Ensuring that your small business payroll forms are filed correctly is one of the best ways to protect your company.
It’s simple, right? Incorrect forms lead to penalties. That’s why you pay attention. Unfortunately, that isn’t always the case.
Every year thousands of businesses suffer penalties, audits, and even lawsuits simply because they misclassified their workforce.
And the worst part is that many of them didn’t even know they were doing it wrong.
But did you know that you can avoid being one of those businesses? When you know what to look for, proper workforce classification is simple. By doing it correctly, you can avoid legal risks and save your business money.
Let’s take a look at how it works…
What you’re going to learn:
- Why Workforce Classification Is Important
- Penalty Fees For Misclassifying Workers
- Classify Your Workers Properly
- Common Small Business Payroll Forms
- Maintain Compliance Year-Round
Why Workforce Classification Is Important
Worker classification is the process of determining if a worker is an employee or an independent contractor. It’s the first step towards filing your small business payroll forms.
Here’s why it’s important:
Employees are people your company withholds income taxes from and pays Social Security and Medicare taxes for. As an employee, workers receive protection under federal laws.
Independent contractors don’t have taxes withheld by their employer. They’re considered self-employed so they’re responsible for their own taxes.
That all seems pretty straightforward, but here’s the catch: Businesses often classify workers incorrectly.
According to the National Employment Law Project, between 10-30% of employers misclassify their workforce as independent contractors. That’s a lot of businesses risking serious legal trouble.
Correcting small business payroll forms starts with your workers. Whether it’s filing out W-2s for your employees or preparing contractor 1099 forms, every worker on your payroll should be classified correctly.
Penalty Fees For Misclassifying Workers
Think worker misclassification isn’t a big deal? Think again.
Both the IRS and Department of Labor take worker classification very seriously. Businesses who misclassify their employees intentionally or accidentally can face severe penalties.
Businesses who unintentionally misclassify workers can expect fines such as:
- $50 fine for each W-2 form that goes unfiled
- 1.5% of total wages paid to worker
- 40% of FICA taxes not paid and 100% of the employer share
- Failure-to-pay penalty of .5% per month up to 25% of total tax liability
That doesn’t even cover it. If the IRS believes you willfully misclassified workers, they can tax you up to 20% of your wages. They can also assess 100% of all FICA tax wages.
If that wasn’t bad enough, you could even face criminal charges and fines.
Needless to say, businesses have discovered worker classification lawsuits can result in…
- Reinstatement of the employee
- Payment of back wages
- Payment of civil penalties and forfeitures
- Payment of damages and legal fees
Thousands of businesses face penalties or lawsuits for misclassification each year. Class action lawsuits are on the rise when it comes to workers trying to recover damages from businesses who misclassified them.
One small mistake on a payroll form can turn into a lawsuit that bankrupts your business.
Classify Your Workers Properly
Avoiding these penalties begins with properly classifying your workforce. So how do you know the difference between an employee and an independent contractor?
The IRS provides common-law rules based on these three categories to determine worker status:
- Behavioral control
- Financial control
- Type of relationship between business and worker
Behavioral Control
Does your company control or have the right to control how and when work is completed? If the answer is yes, that worker is considered an employee.
Financial Control
Does your company control how the worker gets paid? Are expenses reimbursed? If your company has a financial investment in the relationship, that worker is an employee.
Type Of Relationship
Do you provide your workers with benefits? Do you have a written contract? Is the relationship indefinite or for a specific project?
Again, the more control you have over the worker, the more likely they are an employee.
Keep in mind that even if you have a contractor agreement that states otherwise, it doesn’t mean the worker is an independent contractor.
If the IRS examines your working relationship and determines your worker is an employee, your contractor agreement doesn’t matter.
Common Small Business Payroll Forms
Determining the status of your workers is just the beginning. Proper small business payroll forms must then be filed annually.
And while on the subject, incorrect payroll forms are another common source of penalties. In fact, the IRS states 40% of small businesses will be fined for payroll mistakes.
These mistakes include incorrectly calculating withholding taxes as well as filing the wrong forms.
If a business has employees, they should be familiar with these three forms:
- Form W-4
- Form W-2
- Form 941
When working with independent contractors, businesses should know these forms:
- Form W-9
- Form 1099-NEC
Each form has its own individual purpose. Failure to provide one of these forms when required can result in penalties. Make sure you know which forms your business needs to fill out and when.
Maintain Compliance Year-Round
Businesses that discover they misclassified a worker still face penalties. But what can you do to avoid this?
Ensuring your workforce is classified correctly should be an ongoing process. Here are a few things you can do to maintain compliance year-round.
These are the steps every business should take:
- Review your worker classifications. Job roles change, and people move around within a company. Make sure to review your classifications each year.
- Keep good records. Don’t let IRS agents catch you off guard. Keep contracts, invoices, receipts, and any other information that can help prove your case.
- Use a payroll system. Good payroll software will make your life easier. Not only will it calculate withholdings for you, but it can track important deadlines.
- Stay educated. Just because a classification rule is valid this year doesn’t mean it will be next year. Both state and federal rules can change when it comes to employee classifications.
That about covers it.
As you can tell, the businesses who run into costly compliance issues are the ones who don’t take these things seriously. Payroll compliance should be a part of your business model from day one.
Wrapping It All Up
By now you know that proper classification of your workforce can save you time, money, and legal fees.
Here’s your checklist:
- Learn the difference between an employee and an independent contractor.
- Follow IRS guidelines when classifying your workforce.
- Familiarize yourself with common small business payroll forms.
- Stay compliant by using the tips above.
The smart business owners know how to classify workers properly and avoid penalties. Hopefully this guide has educated you on how to protect your business from serious legal risk.