Tax Tip: Independent Contractor (1099) versus Employee (W2)

This question seems to come up more often than not – Am I (should I be considered) an independent contractor  or an employee?  The answer to this question is critical for both the employee (who could lose benefits, such as the right to claim unemployment, and incur higher tax liability) and the employer (who could incur interest and penalties in the case of misclassification).

So how do you define an independent contractor?  And what do you do if you believe you have misclassified?  Let’s take this one step at a time…and start with the definition of an independent contractor, or at least how the IRS defines it.  The IRS uses three broad categories to determine IC status:  Behavior Control, Financial Control and Type of Relationship.

“Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training, or other means.  Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job.  The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.”

What do you do?  As with most things, the lines can get murky so if are unsure about your work status or think that you may have been misclassified,you can ask the IRS to make the determination by filing a Form SS-8 – Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

You can learn more about the critical determination of a worker’s status as an Independent Contractor or Employee at IRS.gov by selecting the Small Business link.  Additional resources include IRS Publication 15-A, Employer’s Supplemental Tax Guide, Publication 1779, Independent Contractor or Employee, and Publication 1976, Do You Qualify for Relief under Section 530? These publications and Form SS-8 are available on the IRS Web site or by calling the IRS at 800-829-3676 (800-TAX-FORM).


Related: 
Employee vs. Independent Contractor – Ten Tips for Business Owners
Publication 1779 
Publication 15-A
Form SS-8

Publication 1976

Disclaimer:  This blog post/article is not meant as tax advice.  Please consult a tax professional regarding your specific situation.

 

How To: Correctly Setup Sole Proprietorship

Before delving into the topic, I think it would be helpful to actually define what is a “sole proprietorship”.  It is a business represented by a single individual without benefit of a separate legal entity (for example, corporation).

This business “entity” type tends to be somewhat popular because of the ease in which it can be “formed”…

  1. Determine if you will use your name (example John Doe) or a fictitious one (JD Photography).
  2. If you will be using a fictitious one, you will need to register it with your state (or city, if required) by filing a “DBA/Doing Business As” or Tradename form.
  3. Apply for a FEIN (Federal Employer Identification Number) – go to www.irs.gov.  Not necessarily a requirement per se but your accountant and/or tax preparer will thank you later.  (If you are a contractor of some sort, you will use this number when filling out W4 Forms).
  4. Open a separate bank account.  Again not necessary but extremely helpful when managing your company finances…your accountant/tax preparer will thank you.
  5. Acquire any necessary licenses.  If your business is one that requires it, make sure you are compliant from the beginning (for example, hair salon requires cosmetology licensing).

As with any business entity type, you should review the pros & cons to decide if that is what is right for you and your business. I thought about going into the pros & cons for this particular business type but decided against it.  Instead I have provided a few related topic links that should cover that base pretty accurately.

Disclaimer:  I am not an attorney nor is this to be taken as tax or accounting advice.  Please seek the advice of a professional for specific insight on your particular business situation.

topic suggested by Malik Alex:  Painter & Aspiring Gallery Owner

Related Topics:
Why You Should Never Operate Any Business As a Sole Proprietor
Sole Proprietorship:  The Right Business Structure?

 

Change of Focus – 2 Cents Blog

Not literally a change, per se, but more like an expansion of focus…

As I have grown as a business owner and grown as a blog writer, I have found that I’d like to write more about growing a small business, as a whole, instead of just the accounting/financial aspect of it.  Now, don’t get me wrong… I’ll still write about accounting, finance, tax preparation/planning issues, payroll vs independent contractor issues, etc but going forward, I plan to write more about the journey of building a business and the things/tools that can help us along the way.

So why the change?  I started my business 7 years ago with the primary aim of providing affordable accounting solutions to small business owners.  That expanded to tax preparation for businesses & individuals…then that expanded to payroll services for small business owners.  Now, I haven’t expanded because I think I know everything or can do everything, out of vanity or any desire of my own.  In the past, as now, I have expanded because i took the time to listen to my clients & fulfill their needs.  As their trusted advisor, I have been asked to point them in the right direction.  So I will use this blog, this platform to do just that… point my aspiring entrepreneurs, microbusiness owners, small business owners in the right direction.  It is my hope that you will look to my blog & my website as an invaluable resource and that you will visit often.

With my expansion of focus, I look forward to having guest bloggers in the near future.  If you have an area of expertise that can help growing small business owners & aspiring entrepreneurs (especially law, marketing & branding)… I want to hear from you!

Cheers!
Joyce

Questions & Comments… as always, are welcomed!

 

End of Summer Reading List

I tend to read a lot (or at least I try to). Lately, I have been reading more thing online instead of off-line but I wanted to remind my fellow entrepreneurs and business owners that learning does not stop when you get a diploma or a degree. Learning continues until, well… you know. Anyway, here are a few of my favorites that I thought would be helpful to others as they begin/continue their journey of independence.

The E-Myth Revisited – Michael E. Gerber
Duct Tape Marketing – John Jantsch
Get Clients Now – CJ Hayden
How To Sell Without Being A Jerk – John Klymshyn
Successful QuickBooks Consulting – Michelle L. Long, CPA MBA (this one is good for consulting in general)

These are books that I have read and re-read…hope you find them as helpful as I have.

Do you have a small business, marketing or branding resource that you have read & refer back to over and over again? Please share your literary choices. Thanks & Enjoy.

 

Q&A: Need Help With Client Engagement

Q: I have a client who has asked me to help him prepare financial statements. In looking at his books, they are completely a shambles. He has 7 (!) checking accounts, and not one of them can I reconcile in Quickbooks because it appears deposits were randomly recorded, or not recorded, checks were recorded with incorrect check numbers or not recorded, transfers were not recorded, etc. Soooo….. my thought, since they’ve been in QB for only 7 months, I might start from scratch and just record everything fresh. My question is, is there any way I can do this while they’re still working in QB? This job will take me a few weeks to complete, and I don’t want to tie their hands while I’m working on straightening out their financials.

A: Before I respond, I have a question for you: will this be an ongoing client where you will review their file and prepare financial statements on a monthly or quarterly basis going forward? The answer to this seemingly benign question will dictate part of how you move forward and the type of engagement you have.

In my opinion a few things need to happen.

First: train whomever is doing their data entry so that it is done correctly going forward. If they are not trained adequately, you will find yourself in the same boat in a few months. The only difference is you will have the added pressure of getting it done quickly because the client will need the year-end statements done for tax time.

Second: decide if anything in their file is salvageable. Was anything set up correctly (vendors, clients, COA)? Can you make heads or tails of any of the transactions? If not, you may need to throw in the towel and start afresh.

Third: the client can work in the file while you review historic information. If you are setting up the new file, set it up, create an accountant’s copy for yourself and send them a copy, make sure the dividing date is one where they can still work and input transactions. Keep in mind there are a few limitations for you (mostly payroll related). I’m not sure if that will create a real problem for you or not since you didnt’ mention if he had payroll transactions for you to reconcile.

Fourth: is there any reason they have SEVEN bank accounts??? If they don’t have a ready explanation, you may want to advise them to cut back on that. Even if they are all free business checking accounts, it’s costing them time & money in the long run. Trying to keep them all straight is obviously creating a problem for their staff person handling the input of deposits and processing checks and may be the source of a lot of the reconciliation/messiness of the client file.

Hope this helps,

Joyce

Post asked & answered on Quickbooks Forum

 

 

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