Every business owner goes through the process of deciding how to hire someone when they get to the point where they’ve outgrown their current situation or just need a bit of extra help.  You’ve found the right candidate and now you need to decide whether or not to hire a contractor or employee…this is where you need to be very careful!

Watch out for the pitfalls

While your first inclination is to hire contractors to save paying FICA and Workers Comp, you should be aware of the rules that the IRS and state can nail you on.  Yes, there may be two sets of rules that you have to abide by!  We’ll explain each one, and since we live in California, the rules here as well.

What the IRS Looks For

The IRS is mainly looking at two factors; Control & Relationship.  Control is what it sounds like, do you have control over how your worker does their work and when they do it?  Do you determine how much you pay the worker?  If the answer is yes, then you most likely have an employee, not a contractor.

Under the Relationship test, does your relationship with your worker resemble an employee or contractor?  Are there written agreements, do you pay for benefits, do you reimburse your worker for expenses?  If it walks like a duck, quacks like a duck, then you most likely have an employee.

Under the Control test, you give up when and how the worker perfoms the work. For example, you take your car to the mechanic for some work.  You walk in and the mechanic tells you how much it’s going to cost and how long it’s going to take to do it.  Now you’re hoping it’s fast because you need to pick up the kids, but you can see what I’m getting at here.  You really don’t have any control over the mechanic in how and when they do their work.  In this case, we’re describing a contractor relationship.  

California

In California, we take it to another level! Oh, how we love the Golden State! New legislation for 2019 enacted more rules for determining contractor status.  (Even if you’re not in California you might as well take heed as I’m sure states will soon follow California’s lead)

California gives you the “ABC” test to help you determine whether or not you have a contractor or employee relationship:

A – Control

This refers to whether or not the worker is free from the control of your business in connection with their performance of the work. Thus, if you are telling the worker when and how to do their job then you are probably going to fail this test.

B – Business

Additionally, the worker should be performing work that is outside the normal course of your business.

C – Customarily Engaged

In connection with A & B, the workers must be engaged in an established trade or business of the same nature as the work performed.

Summing up California

Photo by Vital Sinkevich on Unsplash

As you’re now most likely thinking about what this means for your business, these new rules rule out a lot of what has gone unchecked for many years–hiring just anyone to get around payroll taxes and workers comp insurance. To illustrate, here are a few examples:

Example 1: You run a personal training studio and hire other personal trainers to come in and run training sessions. That’s an employee.

Example 2: You’re a physician in private practice and you hire office staff. This is an employee because they will most likely fall under the “Control” test.

Example 3: You’re a church and you hire a consultant to help you with leadership and other efficiencies. That’s a contractor.

Example 4: You’re a real estate agent and hire a transaction coordinator to help you move all your listing and sales through the administrative pipeline. But they work from home and you don’t dictate their schedule. You can most likely get away with hiring them as a contractor.

These rules can be tricky…no matter what state you live in

The worst thing for you to do is to guess at these rules. Feel free to reach out or comment if you find yourself stuck and caught in the web of employee vs. contractor rules!

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