Thinking About Hiring? Part 1: Important Next Steps

Step 1: Classify workers correctly: Independent contractors vs. employees

What's the difference between an independent contractor and an employee? It's important to classify workers correctly. In fact, classifying employees wrong is one of the biggest mistakes that entrepreneurs make. And, it can be a costly mistake, since there are a lot of rules that govern this area.

For payroll tax purposes, workers are generally classified as employees or independent contractors. Whether a worker is an employee or an independent contractor depends on the amount of control the employer has over the worker.

What's the difference between an employee and an independent contractor? A worker's classification has certain payroll tax implications. Basically for employees you pay payroll taxes (like Social Security), but for contractors you don't have to. A few simple questions can help you determine whether the person you're hiring is an employee (and will need a tax form W-2) or an independent contractor (and will need a tax form 1099).

• Will the work be performed on company premises?
  
  
• Will the individual work only for you?
  
  
• Will you provide tools for your worker to do his or her job?
  
  
• Do you control the hours the person works?

If you answered "yes" to any of the questions above, odds are you're hiring a W-2 employee, and not a 1099 independent contractor. For more detailed information on how to classify a new hire, check out the IRS's Publication 15-A. It’s very important to understand these differences before you start hiring employees or contractors.

While it's tempting to pay someone as an independent contractor since it's less expensive, it could get you into trouble later. In fact, the IRS has started cracking down on employers who classify their workers incorrectly. Read the article at the Wall Street Journal.

Step 2:  Get your employer identification numbers

Once you have decided to hire employees, you will need to get a number that identifies your business to the government. This is an important first step in hiring.

There are a few identification numbers you typically must have as an employer — one from the IRS called an Employer Identification Number (EIN), one from your state revenue department, and one from your state employment department—and you need to check with local jurisdictions as well.

• The federal Internal Revenue Service requires employers to have an identification number called an Employer Identification Number, or EIN. The government uses this number to identify your business and track your federal payroll taxes. If you don't already have one, you can apply for an EIN online — it's actually quite easy.
  
  
• Your state government usually requires a separate ID to track state payroll taxes — usually one for unemployment insurance tax and one for withholding tax if it's applicable to your business. These numbers, like the EIN, will also be used to identify your business when you do things like pay taxes. Consult your state's employer website to learn more about specific requirements in your state.
  
  
• Some local jurisdictions may also require an ID as well. Consult your local government offices or website for details on specific requirements.