Legally Growing Your Team: 1099s vs. W-2s

When we go into business for ourselves, you might dream of growing a big team or you might think you’ll always be a team of one. As you grow, you are going to want help. While you might start outsourcing your weakness by hiring professional service providers for specific tasks, as your business continues to grow you might want to add ongoing help. 

I often see small businesses that mean well, advertise that they want to grow their team. As a lawyer in the online space, there is a fine line between hiring a virtual assistant thattechnically owns their own business and hiring an employee. If you are not careful, the line can easily get crossed, so today, I want to talk about the differences between growing your team with independent contractors and hiring your first employee.

Even though you want to be careful, I also don’t want the fear of hiring your first employee to hold you back. I’m going to outline the differences between an independent contractor and an employee relationship, show you how to avoid crossing the line, and which steps to take when you are ready to take the leap and hire your first employee.

Should your next hire be an independent contractor or employee?

It probably seems easier to just stick to independent contractors, and in some cases it is. But the penalties are steep for treating a contractor like an employee, so if what your business needs is an employee, it’s worth setting up properly. Remember, the goal here is to stay out of legal trouble.

Responsibilities of an employer who hires an employee

With an employee, the employer is responsible for withholding taxes and submitting the correct government forms (A W-2). There are additional costs to consider like employment insurance, benefits, etc. The employer is also responsible for providing all of the equipment that the worker needs to do their job and for training them.

Responsibilities of an employer who hires an independent contractor

With an independent contractor, the only responsibility you have is submitting a 1099 if you paid them more than $600 last year. The contractor is responsible for their own taxes and therefore has the potential to make more money by writing off a portion of their income. They are also typically responsible for growing their skillset and providing any necessary equipment to do the job. They have other clients as well. 

The IRS assumes everyone operates as an employee so it’s important to make sure that you are following these guidelines.If the IRS discovers you are treating an independent contractor like an employee, you will be responsible for paying all taxes and benefits back to the government. It’s also important to note that the responsibility for following these guidelines and deciding whether or not a worker should be classified as an employee or contractor, rests entirely on the employer.

How to Avoid Treating your Independent Contractor like an Employee

Because the IRS will assume your worker is an employee unless proven otherwise, how can you make sure that you are not crossing the line? The IRS looks at 3 categories when deciding whether or not your worker is an employee or independent contractor.

1. Behavioral

If you are deciding when they do their job, they would be considered an employee. This is definitely one of the biggest lines crossed. If you have a virtual assistant, are they working a certain number of hours a week for you? If they have set hours (Monday to Friday between 8am-12pm, for example), they would be considered an employee. The same rings true if they have to come to your home office to work, you can’t dictate where they work as an independent contractor. If, on the other hand, they are working 20 hours a week but they decide when and where, they would be considered an independent contractor. 

You also can’t dictate how the worker does their job as an independent contractor. How much oversight does your worker have? Are they in charge of completing jobs from start to finish? For example, if you are hiring a website designer, they will often be an independent contractor because they are responsible for planning, executing and delivering the project. If you were to manage how they completed the work (the software, the order in which they created the pages, etc), they would be considered an employee.

2. Financial 

The IRS also considers any financial relationship. Who is deciding when and how the worker will be paid? If you are, it is likely an employee relationship. When you hire an independent contractor, they are usually the ones to set the amount they will be paid, how they will be paid (credit card, direct deposit, etc) and when (after the work is completed? Monthly retainers?). As you can see, there are quite a few factors at play!

The second part of the financial relationship to consider are expenses. Are you providing the equipment to the worker to complete the job? That usually reflects an employer-employee relationship. If the person working is responsible for their own expenses and equipment, that leans toward an independent contractor relationship.

3. Type of Relationship

There are a few things to keep in mind when looking at the type of relationship between you and your worker. Are there written contracts outlining your agreement? Make sure the lines in how you will operate are crystal clear and don’t leave any room for confusion. Another thing to consider is whether or not you are providing any employee-type benefits (bonus pay, vacation time, pension contributions). If you are, the IRS will assume your relationship is that of a traditional employer-employee. When looking at the type of relationship, the IRS also considers how fundamental the role is to the business. The more crucial (and ongoing) the tasks are to a business, the less likely it is that the person performing them will be considered an independent contractor.

There is no “one size fits all” when it comes to looking at whether or not a worker is an employee or independent contractor. The IRS looks at all 3 categories to make a decision. Like I mentioned earlier, the penalties for treating an independent contractor like an employee can be harsh. If you are not sure if you are crossing the line, the IRS has Form SS-8 where you can answer a few questions and submit it to them for review. As a lawyer, it’s my job to remind you to be better safe than sorry!

Once you’ve decided to hire your first employee, what’s the next step?

Eventually, you are going to find that your next hire should be an employee. Although there is a lot of paperwork involved with hiring your first employee, it gets increasingly easier with every hire after that so if the goal is to grow your business, you shouldn’t be afraid to get started. 

First, when you officially hire someone, you need to do three things before they start working.

  1. Apply for an EIN (Employer Identification Number)
  2. Obtain workers compensation insurance for your new employee.
  3. File a report to the EDD (Employment Development Department) to document that you have hired someone.

Then, as you start to pay them, you need to make sure that you:

  1. Register and pay employment insurance with your state.
  2. Register and pay employment insurance at a federal level (this doesn’t come from an employee’s paycheck).
  3. Start withholding payroll taxes and submit a W-2 to the IR.
  4. Withhold your employee’s contribution to you state’s disability program.
  5. Pay the employer’s portion of Medicare taxes and Social Security based on your new employee’s wage.

Although this list gives you more than a good starting point, make sure to always confirm with your state to see if they have additional requirements. Most of these steps are only hard for the first employee. It gets much easier for additional hires because everything has already been set up. 

If you find all the paperwork is stressing you out and holding you back from hiring, remember you can always ask your accountant for assistance or hire a payroll company to take care of the remittance. Although it might be more expensive at first, it won’t be more expensive than not growing your company because you don’t want to figure out the paperwork.

Contracts to consider when hiring an independent contractor or your first employee

Whether your next hire is an employee or an independent contractor, make sure you have a contract/agreement. You want to make sure in your agreement that you outline clearly what the employee or contractor responsibilities will be, but there are few other things you are going to want to outline as well.

For an employee, this might include:

  • Start Dates
  • Job Title
  • Compensation (amount and schedule)
  • Vacation policies
  • Holidays
  • Sick leave 

Most independent contractors will have their own contracts, but here are a few things to look for to make sure that you are protected. Keep in mind - an independent contractor’s contract is designed to protect both of you, but it is written for them. 

Make sure the following points are crystal clear in your independent contractor’s contract:

  • The work they are doing for you
  • How much they are getting paid (and when)
  • Who OWNS the copyright and content created (and at what point the ownership is transferred) 

Making Sure Your Contract is Legally Set

If you’ve made it this far, Congratulations! Although it seems like a lot at first, these are necessary steps to growing a business. There are just a few more things to do in order to make sure your business is legally set.

  1. Make sure you have a solid contract. I’m going to recommend you don’t write it yourself by piecing together advice you found on the internet. The best option is to hire a lawyer. If you are on a budget, you can also purchase a lawyer-vetted contract (like these ones by Legally Set).
  2. If you aren’t signing the contract in person, make sure you are using a third-party like Honeybook, that can obtain a legally binding e-signature. I love Honeybookbecause it allows you to check to see when the contract was viewed as well. (PS: If you use our affiliate link you get 20% off your first year).

There you have it! Everything you need to know (and hopefully enough encouragement) to hire your first employee. It’s not as scary as it seems, and it’s likely a crucial step if you want to really scale your business!