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 The Pay Trap
By James L. Silvester
Of course one of the motivations in running a home based business is the avoidance of dealing with one of the most annoying and expensive aspects of entrepreneurship that being managing people.
If you are very successful at your home based enterprise you may find the need to hire additional help to facilitate the growth of the business. Then you face the choice of paying people as independent contractors or as employees. The differences can be very large and pose a few financial risks.
Your instinctive reaction is going to be to pay people as independent contractors and report their earnings on IRS Form 1099. You might be saving some dollars because you don't have to pay their social security taxes, workers compensation insurance premiums, unemployment insurance, and the expense of collecting, forwarding, and accounting for federal and state tax withholding.
But be aware the Internal Revenue Service requires that a person must meet certain requirements before being declared an independent contractor. You can not impose regular hours, force them to be in your office, or manage them in the traditional sense of the word. And the tax penalties are very stiff if you pay someone as an independent contractor and the IRS later determines they should have been declared employees. You could be held responsible for their taxes if they failed to pay their 1099 earnings not to mention the assessment of additional fines and penalties.
Now I'm not trying to scare you because many people can legitimately be paid as independent contractors such as free-lance consultants, web designers, work-for-hire writers, etc. There are general categories widely accepted by the IRS.
It's always safe to pay people as employees and the expenses are all deductible just like independent contractor expenses. You will have to pay 50 percent of their social security taxes, pay workers compensation insurance, and pay unemployment insurance premiums. All in all it will add a 15 to 20 percent cost burden over paying these people as independent contractors.
However, you do have peace of mind the IRS won't knock you over the head at some point. And you are insulated from the independent contractors pointing a finger at you at a later date saying they deserve unemployment benefits when that can't negotiate a future contract with somebody else and thus they have no income. It happens more often than you think. In addition, consider if the independent contractor is injured while doing work for you and you have no worker's compensation insurance. If it goes to lawsuit and the court determines that the independent contractor should have been declared an employee, you are at risk. With no workers compensation insurance, it now becomes a criminal issue against you.
Give it careful consideration and check with your CPA.
Lesson: Check The IRS Website At Http://Www.Irs.Gov/Businesses/Index.Html. They Have Criteria Concerning Declaring Whether A Person Is An Employee Or Independent Contractor.
Quote: Don't Try To Save A Penny By Mining Copper In Your Own Back Yard.
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