Payroll Mistake #1: Classifying Workers Improperly

Avoid Payroll MistakesMisclassifying a worker as a contractor rather than an employee can be a costly mistake.

Why is this important?

Many contractors should be classified as employees, and this misclassification affects tax revenues. A business owner gives a contractor a 1099-MISC rather than a W-2, and deducts no taxes from payments. However, many misclassified workers don’t pay the taxes they should. Plus, business owners get out of contributing employer payroll taxes for the worker.

If the IRS determines that you misclassified a worker, you could pay the employer’s share of payroll taxes, plus the employee’s share, penalties, and interest! A misclassification audit can devastate a small business.

How to avoid this mistake:

Follow IRS guidelines, and consider your degree of control over the work in three areas:

  1. Behavioral: Do you control (or have the right to control) what the workers do and how they do it?
  2. Financial: Do you control business aspects of the workers’ job?
  3. Type of Relationship: Is there a contract? Will the relationship continue? Are there benefits? Is the work a key part of the business?

For more information, read the IRS article “Independent Contractor (Self-Employed) or Employee?” You can also file Form SS-8 to determine your worker’s status.

If you’ve made this mistake:

A new IRS program allows employers to pay an amount equal to about 1% of wages paid to reclassified workers for the past year — provided they properly classify workers going forward. Read “IRS Program Lets Employers Admit to Worker Misclassification” for more information.

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