Hiring Contractors or Employees for your Online Business

Consider your options when choosing between ICs and employees

When you're hiring someone to work for your online business, you have two options: You can hire an independent contractor, sometimes known as a consultant or freelancer, or you can hire a full-fledged employee. This decision affects your tax and legal obligations, the way you run your business, and your profitability. Once you’ve decided which type of worker fits the position you hope to fill, your next task involves choosing the right person, then dealing with tax forms and other reporting and paperwork requirements.

What’s the Difference Between an Employee and an Independent Contractor?

In general, an independent contractor (IC) is someone who provides specialized services on a per-project basis for a number of businesses or clients. Services that an IC provides usually require a certain level of skill, experience, and sometimes licensing — for example, bookkeepers and attorneys are often ICs. You can hire an IC on an ongoing basis — for example, to maintain your online site — or on a periodic basis, to do your taxes each year. ICs also work by the job — for example, to remodel a home office or help an online business launch a product. In comparison, an employee follows the rules you set and meets the standards you require, often at your workplace. As an employer, you exercise a lot more control over an employee than over an IC, from setting work hours to dictating exactly how the employee does every aspect of the job. Although you may hire an employee on a short-term basis (such as helping you during the hot selling seasons), employees are more commonly hired on an open-ended basis, such as until the work runs out, or he or she quits or is fired.

Sometimes it may be tough to tell how a worker should be classified, but it is usually straightforward: If you’re hiring someone who runs his or her own business and you are a customer of that business, you’re probably hiring an IC. If you’re hiring someone to work for your business, subject to your control and your standards, you’re probably hiring an employee.

For typical online business tasks, you're likely to hire workers on the following basis:

  • Setting up Your Website or online Store. You are probably better off hiring an IC for the task of setting up your site, a task that is fairly well-defined, complicated and short-term. You will need someone who has had a lot of experience accomplishing this one task, and that is more likely to be an IC who makes a living doing so. Also, because most ICs are paid by the project (unlike employees, who generally are paid for their time), ICs have a stronger incentive to finish the work quickly. The sooner you are up and running, the better!
  • Day-to-day online Business. Employees are usually a better choice to do work that is an integral and ongoing part of your online sales business, such as listing items, shipping orders, and dealing with customers. If hiring employees to do this work, you’ll have more control over their training and the quality of their output, and you will have someone helping you who understands your way of doing business and provides consistent service to customers, all essential factors in establishing your company's reputation. You are also likely to satisfy the IRS if it checks the classification of your helpers in an audit. If your workers are doing the tasks for which online businesses are known, the IRS is much more likely to classify them as employees, not ICs. Misclassifying workers can get you in big trouble, as described below.
  • Accounting and Inventory. Accounting, inventory, and other types of data management may be handled by ICs or employees depending on the size of your online business and the frequency that these tasks are performed. For example, large online businesses may hire employees for part-time or full-time inventory management, while a startup company may hire an IC for a short time to manage an annual physical inventory or set up its bookkeeping system.

How Does the IRS Decide Who is an IC?

The IRS looks at a number of factors when determining whether a worker is an employee or an independent contractor. The agency is more likely to classify as an independent contractor a worker who:

  • can earn a profit or suffer a loss from the activity
  • furnishes the tools and materials needed to do the work
  • is paid by the job
  • works for more than one firm at a time
  • invests in equipment and facilities
  • pays his or her own business and traveling expenses
  • hires and pays assistants, and
  • sets his or her own working hours.
On the other hand, the IRS is more likely to classify as an employee a worker who:
  • can be fired at any time by the hiring firm
  • is paid by the hour
  • receives instructions from the hiring firm
  • receives training from the hiring firm
  • works full time for the hiring firm
  • receives employee benefits
  • has the right to quit without incurring liability, and
  • provides services that are an integral part of the hiring firm's day-to-day operations.

 Posting Terms and Conditions

Many online stores reflect their shipping, return and other policies in their “terms and conditions.” Do you need conditions and terms at your online store? Maybe. Below is an explanation for some common T&Cs.

Disclaimers. You may want to include disclaimers — statements that inform customers that you won’t be liable for certain kinds of losses they might incur. For example, you may disclaim responsibility for losses that result if pottery breaks when a customer ships it back for return.

Privacy. If you are gathering information from your customers, including credit card information, you should post a privacy policy detailing how this information will be used or not used. Yahoo!’s privacy policy is a good example of a broad, easy-to-understand policy. Whatever policy you adopt, be consistent, and if you are going to change it, make an effort to notify your customers of the change.

Chats, Reviews, and Comments. If your website provides space for chats, product reviews or postings from the Web-surfing public, you’ll want to limit your liability from offensive or libelous postings or similar chat room comments. There are three things you can do.

  1. Regularly monitor all postings and promptly take down those you think are offensive or libelous.
  2. If a third party asks you to remove a posting, remove it while you investigate. If you determine — after speaking with an attorney — that you are entitled to keep the post, then you can put it back up.
  3. Include a disclaimer on your site that explains you don’t endorse and aren’t responsible for the accuracy or reliability of statements made by third parties. This won’t shield you from claims, but it may minimize your financial damages if you’re involved in a lawsuit over the posting.

Legal and Paperwork Requirements: ICs  

There are only a couple of legal requirements you need to meet when hiring an IC.

Get the IC’s taxpayer identification number.  The IRS knows that many ICs are paid "under the table;" i.e., in cash, and that they either don’t report or underreport those earnings to the IRS. To put a stop to this, the IRS requires those who hire ICs to get a copy of their taxpayer ID — their employer identification or Social Security number that they use on their tax returns. If an IC won’t give you an ID number or the IRS informs you that the number the IC gave you is incorrect, you have to withhold taxes from the IC’s pay and remit that money to the IRS. (The IRS calls this “backup withholding.”) Obviously, you want to avoid this extra chore — and you can, by requiring the IC to fill out IRS Form W-9, Request for Taxpayer Identification Number. If the IC doesn’t have an ID number yet, you don’t have to start withholding until 60 days after he or she applies for one.

Write down your agreement with an IC.  Do not hire an IC for more than a very minor project without signing an agreement. You are not legally required to do so, but creating an IC agreement helps you and the IC clarify the terms of your deal, creates a written record of exactly what you agreed upon, and can help convince the IRS and other agencies that you and the IC did not intend to create an employer-employee relationship. Projects that involve the creation of written or design materials, as in designing a website, especially require a written agreement, as the law presumes that the person who creates it continues to own the copyright in it, unless there is a written agreement that states otherwise. At the very least, an IC agreement would include a statement of the services to be performed, the fees, the time period for completion, a statement regarding the working relationship (for example, that the worker is an independent contractor, not an employee), and a process for resolving disputes. For help creating a written IC agreement, take a look at  Consultant & Independent Contractor Agreements, by Stephen Fishman (Nolo).

Complete and file IRS Form 1099-MISC, Miscellaneous Income.  Form 1099 is very straightforward, and you only have to complete and file it if you pay an IC $600 or more in the tax year. You simply enter identifying information about your business and the IC, then enter the amount you paid the IC in the box marked “Nonemployee compensation.” You must provide copies of the form to the IC no later than January 31 of the year after you made the payment, which gives the IC an opportunity to correct any mistakes in his or her identifying information. You also have to file copies of the form with the IRS and possibly your state taxing authority (you have to file with the IRS by February 28 of the year after you made the payment; check with your state tax agency to find out its filing deadline). When you file the 1099 with the IRS, you must send along IRS Form 1096, Annual Summary and Transmission of U.S. Information Returns. Form 1096 is essentially a cover letter for the Form 1099s, on which you state how many 1099s are being submitted with it. If you are transmitting Form 1099-Misc to the IRS electronically, then a Form 1096 is not required.

Finding the forms. You can download both  Form 1099  and  Form 1096  from the  IRS website, where you can also find additional details on  filing.

Getting Started as an Employer

Before hiring an employee, you must do some work to legally establish yourself as an employer. These tasks essentially let the government know that you are hiring people, and trigger some ongoing filing and other requirements

Get an employer identification number (EIN) from the IRS.  You’ve probably obtained an  EIN, but if you haven’t,  apply  for one before hiring. You will need it when completing various government forms, reports, and returns required of employers.

Don’t forget workers’ compensation insurance.  Many states require all of its employers to have  workers’ compensation coverage, obtained either through paying into a state fund or buying a separate policy. Some states exempt employers with no more than two or three employees from this rule, but it might make sense to purchase coverage anyway. Beyond the legal requirements, having workers’ compensation coverage can save you a bundle if one of your employees is hurt on the job.

Register with your state’s labor department.  Once you hire an employee, you are obligated to pay state unemployment taxes. These payments go to your state’s unemployment compensation fund, which provides short-term relief to workers who lose their jobs. Typically, you must complete some initial registration paperwork, then pay money into the fund periodically. Unemployment compensation is a form of insurance, so the amount you pay in will depend, in part, on how many of your former employees file for unemployment (just as your insurance premiums depend, in part, on how many claims you file against the policy).

Finding the forms.  Start at the federal  Department of Labor Map, which provides a link to each state’s unemployment agency. Once you get to your state agency’s website, look for a tab or link on unemployment or find the material for employers or businesses. Many states provide downloadable forms and online information on your responsibilities.

Hang up required posters.  Even the smallest businesses are legally required to post certain notices letting employees know their rights under a variety of workplace laws. The federal government wants you to put up a handful of notices; many states have additional posting requirements.

Finding the forms.  The federal Department of Labor’s website has a special page detailingposter compliance requirements; it also provides downloadable posters. Your state’s labor department probably also has any required posters on its website. If you’re having trouble figuring out which requirements apply to you (or you don’t want to post a dozen different notices), you can usually purchase an all-in-one poster that combines all required state and federal notices from your local or state chamber of commerce.  

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