Thursday, September 4, 2008

Independent Contractor vs. Employee Part II

Previously we talked about the employee vs. independent contractor situation that many organizations face (both for-profit and non-profit). To read the original post, click here. That post has received an unbelievable amount of interest, it seems there are a lot of people and nonprofit organizations out there trying to figure out how to deal with the independent contractor vs. employee situation. So, I decided to expand on the original post and demonstrate that this transition is not as costly as one may think and it worth it in the long run.

In my previous post, I explained how to figure out whether someone is an independent contractor and what it means if you have misclassified independent contractors. For many organizations, they may realize they are misclassifying their independent contractors but have no idea how to change it, or just simply don't have the money to change them to employees.

I wanted to take a little time today to discuss this transition and the costs involved. When paying someone as an independent contractor there are typically few costs involved, you pay them for their work (and give them a 1099 at the end of the year) and sometimes you reimburse them for things like mileage or printing. You don't pay any FICA taxes for them, and they are responsible for turning in their share of federal and state income taxes in addition to paying a self-employment tax.

With employees, costs can rise significantly. With employees, you pay the employer portion of FICA (6.2% of gross compensation up to a limit of $102,000 of compensation) for social security and medicare. You also will typically provide benefits (depending on the benefit package your organization has), pay overtime, need unemployment insurance and if you don't currently have any employees, you will have to set-up payroll (either in-house or via a payroll service).

With all these new and additional costs, many nonprofit organizations continue to misclassify their employees to save money. Having worked with an organization on this very transition, I can tell you it can be done. It doesn't cost as much as you would think and it is worth the cost to avoid the risk of being sued by a misclassified independent contractor or being fined by the IRS.

What exactly does it cost? This will vary organization by organization. I will use the organization I worked with as an example. They were paying their independent contractor and acting executive director $44,000 per year. They recognized that the contractor was definitely an employee, so they decided to change their status. They had three new costs associated with this change- FICA, payroll service and unemployment insurance. They didn't have to worry about overtime pay because it was a salaried position. They didn't provide health/dental insurance to start (it was a goal once they had enough money). They did provide paid time off- which didn't cost them anything and would help staff retention. So, for the $44,000 position it cost them approximately $2,700 annually for FICA (6.2%) and about $1,000 annually for unemployment insurance (this cost varies depending on organization and state). The other cost was the cost to secure a payroll service. They didn't have the staff time or expertise to manage payroll in-house so they hired a payroll service. The payroll service only cost about $30 per month ($360 per year) and took care of withholding and paying all taxes for both the organization and the employee, providing w-2s and keeping the organization updated on employment laws. So, the entire additional annual cost of having an employee instead of an independent contractor was about $4,000, or about a 9% increase. This is very minimal and manageable, especially if your organization is small and only pays it's independent contractor $10,000 per year.

I hope this helps organizations avoid the risk of misclassification. If you have any questions about this for your organization, feel free to contact me.

Click here for Independent Contractor vs. Employee Part I.


Alexander said...

Hi great blog very interesting

Schnitt said...

Most non-profits never turn in a 1096 to the IRS so they have no clue there were ever 1099 contractors on the take.

Or like most they just say they were purchasing B2B service, Services are not taxable in most states and at the federal level