It is part of the Complete guide will be in three parts, we covered in Part 1, why this matters and what are the motivations of either an employee or a business to be classified as an employee or contractor. We're going to talk about the business requirement when working with an independent contractor as in Part 2. Then some of the tips I give to my clients about how to deal with independent contractors in Part 3.
Now we will talk about state rules, every state can have different labor rules affecting overtime. Pay leave break policy type of insurance required licenses wage garnishment procedures this will vary state by state. And we will share some tips in the end.
Unfortunately, I can't get into every single state on this blog but I think it's worth mentioning. That some states might be more contractor-friendly and more employee-friendly. What that means is typical if the state collects revenue. So if you have a state that collects income taxes at the state level.
Those are typically going to be more employee-friendly because they're gonna want to enforce employees. So they can collect payroll taxes I mean that shouldn't be a surprise and then some states that don't collect that much. When it comes to payroll taxes or payroll benefits like Florida. Only Florida unemployment is collected. There are many more locks on the rules not that they break the rules or don't follow them.
It's just that they're not; they don't have as many strict procedures and they tend to follow more of the IRS standard. But specifically, California starting January 1st, 2020, passed a law last year the B 5 is called, which creates a new set of restrictions for California corporations. Or any corporation employing in California that might push or tip the scale more towards employee versus independent contractor California.
It's an employee-friendly state, they'll side more with the employee when there's a dispute. So let's talk briefly about California's B 5, I’m not an attorney and I'm not licensed in California. I can't get heavily into the details. But as I mentioned this takes place January 1st, 2020 facts businesses as of that date and there's a three-part. They call the ABC test and this is going to not necessarily override the IRS.
This is going to sit on top of the IRS rules so one does the hiring entity has control over how they work. How the worker performs the work IRS has the same rule so they control the training that detailed instructions that sort of then. We have their work performed outside the usual course of business so that an employee is doing a main product or service that the business offers.
The example of the restaurant and the cook and the server or is it something sort of outside the main core what the business offers and three is that worker engaged in business with other entities are they offering the services way to potentially competitors someone else and this three-part test is all three
So it's not like the IRS where there's the three that we mentioned and all the details and ss8 form with all the questions. It's just one sort of skill tips one way or the other California it's about meeting all three of these. So there are a lot fewer rules but you have to meet all three.
So if you work in California and you're not sure if your business qualifies or not you may want to work with a local CPA or a local attorney to make sure that in your particular case you are not breaking any rules. When it comes to these new a b5 now let's talk about employer requirements from working independently with independent contractors.
So number one collects a w-9 form you can just google w9 collect a w-9 form from the independent contractor that's going to have their name address and social security number before you make the first payment just say look I can't release the payment until I get the w-9 form because typically what ends up happening is you pay that contractor all year long.
You ignore this whole concept then you go to your accountant asked you for w94 and then the contractor is nowhere to be found so now you can have a compliance problem because you can't file 1099 without a w-9 form that contains that IRS information IRS required information from the independent contractor so have them give you the w9 before you issue that first check
Now the second one is you might need to separate the difference between compensating that worker for work perform versus purchasing inventory for them or reimbursing them force applies or contractually stated out-of-pocket expenses because you're only going to including 1099 the labor portion if you have a relationship with a contractor but you pay them both labor and parts or labor and inventory that sort of thing
Now when you issue the form by January 31st of the following year you must issue a 1099 miscellaneous form this is for the tax year 2019 and then for the tax year 2020 and Beyond it's going to be the 1099 NEC form they change the form I don't know why they just did four so for this tax year that just finished 2019 for the 2020 portion of tax preparation you're going to do a ten a nine in miscellaneous but the next year you'll be doing a ten a nine NEC the forms are similar.
It's the same mechanics but anyway you have to file the form by January 31st of the following year and you have to file it to the IRS and then give a copy to the contractor. I suggest that you get some sort of proof that the contractor received it that way. There's no hearsay afterward that they didn't get the form or whatever and then lastly only checks payments in cash or electronic transfers that are not paid through a merchant processor.
Included herein other words if you're paying that independent contractor through PayPal or you pay them with a credit card and using a merchant processor. You will not issue 1099 for those types of payments because PayPal or the credit card processor is responsible for reporting that. So the IRS doesn't want to see duplications eight-ten and nine from them from the employer from the business and a 10k from the PayPal or merchant processor.
So keep in mind that if you're not paying them with a check or wire transfer or cash and you're doing some sort of merchant credit card payment you may not have to issue a ten a nine or at least partially for those funds you wouldn't have to. Lastly, what are the tips that I give to all my customers and all my clients when it comes to working with independent contractors so this is key right here is what my customers pay me for my advice?
I'm giving this advice to you for free proactively. So one has a signed contract upfront and makes sure that an independent contractor signs a contract with the business. The contract States the relationship. It states their independence and the temporary states that are based on a specific job or a specific limit in time right now it's not a permanent contract.
It's a short-term contract and typically that contract will help you say phase all the other tests matter and all the other IRS and state rules matter. But that contract itself sets the tone and sets the pace in the event. If there's an audit or an investigation or some sort of second, make sure these contractors bring their tools and bring their equipment.
They're fully trained and know how to perform the work. You're not going to be on top of them, you're not going to put a supervisor on top of them, let them dictate their schedule even though you have deadlines. They can still work because they have their schedule. Make sure that they always have a risk of losing on their side if they screw up they have to do it again they lose not you.
That's also just a good business tip altogether but make sure that the contract itself. Customarily in the course of transacting with them make sure that they can lose if they do things wrong if they make mistakes the other one is making sure. You're working with people that are insured, they're licensed.
They're permitted to make sure they have a legal capacity to do that work because if you have a copy of the license a copy of their insurance is a copy of the permits? You can prove to them that they are in that line of business and that's what they do for a living. They do that for multiple businesses. It's not that you drag the man as an employee.
And want to pay them as an independent contractor to save money on taxes, whatever this is a customary thing. This is a usual course of business for both of you now. I would say as a bonus work with independent contractors that are incorporated I have their LLC they have their S corporation they have their corporations. You're paying them through the business that reduces most of the risk to them to the employer now the IRS.
The state is always going to look for stuff substance over form so just having a corporation having the contract doesn't necessarily fix the whole situation that relationship test and the financial control that behavior control all that stuff stills matter. But I think for the most part again it sets the tone these are two independent parties working with each other.
Also, let the contractor dictate payment terms right, they're going to invoice you and they're going to tell you by. When you need to pay them don't issue their paychecks at the same time. I should issue your payroll checks so that the independent contractor who comes every Friday makes the same line as the employees do to collect their paycheck. Most importantly don't call it a paycheck. It's not a payroll check, it's an invoice payment.
So make sure that's a really important thing and also no timesheets right. They should not be keeping any timesheets timekeeping should be their issue. That should be invoicing. They can invoice you for their time. They cannot be using the same timesheets that you use to control the hours of your internal employees that are going to tip the scale way towards employee versus independent contractor. Finally, don't call them an employee, don't call them a team member right.
If you make them think that they're an employee, you make them think they're a team member even though you've done all these other things to make sure you pay them as a contractor. They're still going to show up to the unemployment line when you're at this point when you stop paying them. They're going to tell my employer which it was.
They called me an employee and you know I was part of the team they stopped paying me not to let me collect my unemployment check too anyway. I hope you like this blog. I'm going to create a whole series of this real sort of top-level tax tips our small business owners need to keep in mind to keep their taxes compliant and save as much taxes as legally possible.