If you’re a small business owner, payroll is probably by far your largest expense. So how can you save money without reducing your workers’ salary? One way is by being smart with employment taxes.
How to Classify Your Workers for Tax Purposes
Tax-wise, there are two main ways to categorize the people who work for you: as employees or as independent contractors. Employees receive a W-2, while you record contractor pay with a 1099.
You don’t have to pay employment taxes for independent contractors, so that can save you money. But, since the contractor will have to pay self-employment taxes on what you pay them, they may expect higher pay to account for that.
It’s important to note that the IRS has certain rules for who can and cannot be classed as an independent contractor. Violating those rules can leave you on the hook for employment taxes anyway.
So what’s the difference? The IRS looks at a few main factors when making this determination:
Behavioral control
Do you tell the worker where and when to do the work? Do you provide supplies and training they use to do their job? Do you monitor and evaluate the way in which they do their job rather than simply the end result? If the answer to all these questions is yes, then the worker is almost certainly an employee rather than an independent contractor.
Financial control
Do you pay the worker a salary or are they paid for each job they complete? Does their contract prohibit their working for others while working for you? If so, they are probably an employee.
On the other hand, if the worker has an opportunity for profit or loss as a result of their work, they are probably an independent contractor.
Type of relationship
If you have a contract stating that the worker is an employee or an independent contractor, that is a factor in determining their status, though in and of itself it is not decisive.
An expectation that the working relationship will continue indefinitely is an indication that the worker is an employee. Meanwhile, a contract that specifies that the relationship will continue only for a specific time period or for the duration of a specific project suggests an independent contractor relationship.
If the worker provides a service that is key to the regular business of the company, that can indicate an employee relationship. For example, a teacher working at a school could argue that they are providing a key service.
It’s a good idea to consult a tax professional when making these decisions for your business, since they can provide guidance on your particular situation.
How to Save Money on Employment Taxes
Even with employees, there are ways to save money on your taxes. First, make sure you cover the basics: pay your taxes correctly and on time! Also, make sure that you take all the deductions that are available to you. This is another instance in which an experienced tax preparer is more than worth their fee.
Make sure your business is structured in the most advantageous way. Forming a corporation might help you save money on your taxes or it might not, depending on your particular situation.
You can save on taxes by offering fringe benefits to your employees instead of compensating them solely through cash bonuses and raises. Many of these are not taxed, such as 401(k) plans, health insurance benefits, and flexible spending accounts. Your employees will save money too, so it probably won’t be difficult to sell them on the idea.
Work With a Professional
As a small business owner, you want to keep expenses low while keeping your employees happy. Being smart with how you pay your taxes can accomplish both those goals. Contact us to work with an experienced financial advisor on your business decisions.
