Independent or Not? How Worker Status Affects Small Business Taxes

Small Business
Small business owner planning for small business taxes using a tablet computer

If you're a small business owner, chances are there will come a day when you need some part-time help to keep things running. Traditional part-time employees is a viable solution. But have you considered the problem from the perspective of small business taxes? If so, you're probably familiar with the term "gig worker."

Gig workers, also known as independent contractors, work fewer hours than full-time workers. They're different from traditional part-time employees, however, because they aren't technically employees at all. Instead, they're considered to be self-employed. This can bring certain financial advantages for your company — if you designate the gig workers appropriately.

What's the Trade-off?

The wages you pay independent contractors is tax-deductible, like employee compensation, but there's an important difference from a tax perspective: You're not obligated to pay the employer's share of Social Security or unemployment taxes.

A recent Bureau of Labor Statistics report estimated that payroll taxes and employee benefits add up to around 30 percent of the average total compensation of private-sector workers. "Legally required" pay components like Social Security, Medicare, the federal unemployment tax (FUTA) and state unemployment insurance can together represent one-third of that 30 percent total. Independent contractors, however, must cover their own Social Security and Medicare taxes, as well as any other benefits they need to secure (like health insurance). This can be a major incentive to small businesses without the means to support large payrolls.

Being free of these tax obligations isn't necessarily a "free lunch" for you as an employer, however. Independent contractors must charge you enough to cover those missing costs themselves. The advantage of working with contractors is you can essentially only buy as much of their time as you need.

Who's Really Independent?

You can't just arbitrarily designate anybody as an independent contractor, however. The IRS has strict standards for doing so, and those standards have implications for the choice between independent contractors and part-time employees.

As far as an introductory independent contractor vs. employee checklist, the IRS's general rule is that "an individual is an independent contractor if [the company] has the right to control or direct only the result of the work, not what will be done and how it will be done." That means if you need part-time support from someone but will have to give detailed instructions regarding when, where and how they work, you may need to hire a part-time employee. This could be the case if, for example, you needed someone to fill in for a receptionist who will be taking afternoons off during the summer.

If, on the other hand, you needed someone to redesign your website, an independent contractor could probably handle it. In that case, you'd be more concerned about the end result than when (in terms of specific working hours), where and how the person accomplished it. The same might be true of someone you'd hire to write a report or perhaps do some research.

The IRS urges employers to "consider all the evidence of the degree of control and independence in the employer/worker relationship" in determining whether you need to treat someone as a part-time employee or independent contractor. To help employers with this, the IRS describes three categories of control a company can exercise: behavioral control, financial control and the nature of the relationship. In other words, you'll probably want to designate your workers' status with care.

The Upshot: It's Subjective

When it comes to determining small business taxes — and, specifically, whether an independent contractor's status is appropriate — the IRS says each case can be unique, requiring a subjective assessment. But some kinds of workers are much more easily classified as independent contractors than others. These may include computer programmers, grounds maintenance workers, auditors, graphic and industrial designers, photographers, video producers and technical and marketing writers, to name a few.

You may discover that you and a current employee could both benefit from converting them to independent contractor status, no matter what their position. But keep the IRS's criteria in mind if you do — and don't be afraid to reach out for professional help when it comes to taxes, company finances or even providing benefits for full- or part-time employees.

IMPORTANT DISCLOSURES

1 Source: LIMRA, a life insurance industry association trade group, January, 2016
2 Source: U.S. Bureau of Labor Statistics (www.bls.gov)

Information provided is general and educational in nature. It is not intended to be, and should not be construed as, legal or tax advice. Western & Southern Financial Group and its member companies (“the Company”) does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. Consult an attorney or tax advisor regarding your specific legal or tax situation.

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