We get this question a lot. “I have projects I am working on where I will need 10-15 people for 3 months while I develop project X. They will sign W-9′s and receive 1099′s at the end of the year even though this will be the only project they work on. Do I put them in my personnel plan to show more headcount?”
The answer is no. This is a common mistake made amongst business owners and employers. While state law may vary, here are the easiest ways to decide whether your support “staff” should legally be W-4 employees or W-9 contractors.
Independent or W-9 contractors need to meet several criteria:
- They aren’t called employees
- They don’t technically have a boss or supervisor
- They don’t report “hours” on a weekly basis—they submit invoices like any service provider
- They perform all of their project work through an engagement contract
- They market themselves as self-employed, and seek work from multiple entities
- They pay quarterly estimates on their taxes as self-employed individuals 7. They use their own equipment—computer, phone, office, etc.
- They itemize their business expenses at the end of the year
- They have a local business license
- They pay their own city, state, county, and federal business taxes
The basic litmus test as to whether you should treat someone as an employee or a contractor is really just this: are they freelancing for you, or are they employed by you? Does the engagement have specific boundaries, guidelines, and an endpoint? If so, then that is a W-9 contractor and should be listed in the profit and loss as an expense, not in headcount with matching benefits. If you are paying these individuals benefits, are maintaining the legally required workers compensation insurance, contributing to the workers benefit fund (WBF), and matching social security, then they should be in the headcount as W-4 employees.
You’ll notice when you place a person in headcount—and in turn need to calculate the benefits you pay for them—the average cost per worker rises by about 18%. That’s because you are matching social security and making good on the litany of other expenses state and local governments require.
Tempted to inflate your bottom line by calling employees “contractors?” Be careful. As the government seeks more ways to increase revenue in this economy, there is intense scrutiny in store for employers shortchanging the system by not paying the required employment taxes. When it comes to unemployment taxes and workers compensation, there is no judge and jury—the state alone makes the call, and doles out the penalties.
True story: my relative ran a small business from 1998-2003. During that time she allowed her husband to keep the books and pay the taxes and bills. As a shareholder in the company, she was liable for the state and local taxes as much as her husband was, whether she was privy to how the books were managed or not. In 2009 she received a letter saying she was out of compliance on workers compensation for a short 6-month window in 2003—and the state of Oregon required her to pay $55,000! She was divorced and was unaware her husband had been treating the employees as cash expenses for that time, but it didn’t matter… she was liable too. She was fortunate to settle the matter for $15,000, but the policy itself would have been only $500 at the time. Sometimes it takes the state awhile to catch up… but they will.
If you are an employee and nothing is being withheld from your paycheck, you should know you are self-employed. In many cities you are required to have a business license to operate as such, and you should be paying 15% of every check to social security (usually the employer pays 7.5%), in addition to federal and state taxes. If you’re not doing this, the government will come for their pound of flesh January 15th in back quarterly payments. As a self-employed contractor who filed a W-9, you should be prepared to pay nearly 45% in taxes.
Account for this all correctly in your business planning to reflect more realistic bottoms lines—and to avoid huge headaches in your business.