How to Reclassify Your Workers to Stay in Compliance
As a general contractor, you’re familiar with and successful at running jobs and completing projects. This is in part due to the great team you’ve assembled. Your crew might consist of employees, subcontractors, independent contractors, or some combination of the three. For the most part, things run well. Everyone knows what their contribution is, and you supervise and train when necessary. Yet, like most businesses, yours will evolve. Over time the work done by your employees or independent contractors may change too. Or, perhaps from the beginning it was hard to understand the scope of work for each role. You may have signed a subcontractor on as a full-time independent contractor or 1099’ed someone who should have been an employee.
But once you’re rolling, it’s hard to stop and make a change to a seemingly well-oiled machine. This is especially true if you have a lot of momentum behind you and jobs ahead of you. If it’s not broken, why fix it? The reality is that the correct classification of employees and independent contractors is so important that the IRS and your state employment department actively watches small companies just like yours. Unfortunately, many general contractors make the mistake of misclassifying what should be an employee as an independent contractor.
(We recently published a blog which outlines the IRS test used to determine whether your independent, annually 1099’ed contractor is really your employee. If you have a hunch you might have misclassified your team members or their work has evolved over time, you’ll find this blog to be helpful before continuing).
Changing Employee Status
If you’ve assessed your independent contractor and determined that, based on the IRS test, they really should be classified as an employee, don’t panic. The switch over in status is straight forward. Once you’ve decided to move your independent contractor over to employee status, your first step will be to write up an employment agreement. If the idea of moving someone to permanent employee status is scary, include a probation period clause in the employment agreement. A probation period is typically three to six months. This allows for easy and reasonable termination of an employee if they are not a correct fit for the job or not meeting your standards during this time.
Updating Tax Compliance
The second step you must take revolves around taxes. You’ll want to move your independent contractor from a 1099 status to a W-2 status. To do this, you’ll need to have your new employee complete an IRS form W-4. Once you have the W-4 completed, you’ll have the information you’ll need to begin tax withholding and other deductions. This will apply to Federal taxes, State taxes, Social Security, Medicare, and Unemployment. This responsibility falls on the employer. IRS finds many businesses trying to keep their team members classified as independent contractors for this reason.
To make payroll straightforward, set your new employee up on a payroll system or service. Running a payroll weekly or bi-weekly removes the burden of tax withholding because it’s done automatically with every check. The IRS loves this, since you’re paying in increments as you move through the year. (If payroll is not yet a practice in your business, download our free eBook detailing the 4 Reasons Smart Contractors Use Payroll). You’ll want to decide how often and what amount you’re paying your employee, hourly or salaried. This should heavily depend on the work they will perform and how crucial their contribution is to your projects. (Be careful here – hourly workers are owed overtime for work beyond forty hours in a work week. Not all employees can be considered salaried – it depends on the work they do.)
Adjusting Worker’s Compensation
Once you have your employees set up on a payroll system, you need to make sure you have property worker’s compensation insurance coverage. Worker’s comp protects your business from the costs of an employee injury on the job. You can determine how general or specific you want to be in reporting your employee’s duties; the scope of their work will impact the payment you make each month. If your employee’s position is more dangerous (roofing, for example) but the work he’s performing only reflects that risk 40% of the time, it might be worthwhile to report his duties hour-by-hour on his time card. Completing a detailed reporting form for your worker’s compensation carrier will ensure that you pay only the rates consistent with your team member’s duties.
Switching your misclassified team members from independent contractors to employees may mean additional cost. It’s nothing considering the price you’d pay if the IRS or your state found you out of compliance, though. So, what’s in it for you, the employer? Well, running a compliant business is the first major bonus. No more worrying about a disgruntled prior team member turning you in to state and federal authorities. The second benefit is that now you have the freedom and authority to manage, direct, train, and supervise employees in a way that hiring only independent contractors just won’t allow.
Have questions on transitioning a contractor from 1099 to W-2 status? We have the answers!
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