Part of the philosophy behind the hackers guide to payroll taxes is that it is sometimes better to absorb a small fine than spend hours doing something the "correct" way. That is because it is easy to spend hours avoiding a minimal fine that you are unlikely to get hit with anyway. However, there are also areas where you can make a mistake that can cripple your business and even your personal finances and this is one of those.
Note: Stuff like this is where your accountant is worth every penny. There might not be a bigger risk you are taking in running your business.
Using contractors instead of employees is something you should do whenever it is allowed. Not only do you avoid payroll taxes, but you are often supporting another small business and that is good for everyone. However, knowing when you are allowed to pay someone as a contractor instead of as an employee is tricky if:
- They are working for you full time or almost full time.
- They don't provide this service to lots of other customers in the same year.
- They are not part of "real" businesses.
This is because the IRS wants you to pay payroll taxes and you don't want to pay payroll taxes and there is no real concrete difference between a contractor and an employee (both are people you pay to work for you). According to the IRS the difference is how much control you have over the way the work is completed. If you have ever hired a contractor to do work you know a lot about you know that this rule is nonsense, but don't worry, the IRS has come up clear and easy to understand rules to determine if you have a contractor or an employee (this was thick with sarcasm):
The best part of all of this is that if you make a mistake this is one of the few accounting errors that can result in your personal assets being taken (not just your business). Just like "sales tax" the IRS can say that you didn't just fail to pay taxes, but you actually took possession of payroll taxes that should have been paid.
Because of this issue we know of several business owners that refuse to hire any contractors for more than a few hours of work. This isn't practical in many cases and we love to support small business owners so here are some of the rules we follow at Monchilla.com when hiring outside help to try to stay out of trouble.
- We never hire any contractor that wasn't already in business before we met.
- We never hire any contractor that doesn't have an EIN number (we don't do social security numbers for businesses).
- We always get an invoice from the contractor.
- We never hire any contractor that tell us they have other clients that year.
- We never hire a contractor that doesn't have business name - no people's names.
Even if you follow these rules there is definitely no guarantee you won't get nailed so talk to your accountant.