According to the Internal Revenue Service there are only two employment types, independent contractors (1099-employees) and regular employees (W-2 employees). This legal relationship determines how taxes are handled and who is responsible for which taxes.
How to determine hiring status
From the IRS website we read, “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. . . You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done).”
It is important to classify employees correctly. The fines for misclassifying are quite high. If in doubt, talk with an attorney.
In the startup phase it is not unusual that an owner will use only independent contractors. (Also see: How therapists get paid in a private practice.)
Doing so allows the owner to delay the formation of a corporation. If the beginning is gradual, there are not many advantages to forming a corporation right away. Starting up and maintaining a corporation has annual costs. Delaying these costs may make sense. Additionally, tax rules for independent contractors are far simpler than for employees. That may work well when starting up, especially if the early employees tend to only work a few hours per week.
Of course, the hope is that caseloads grow beyond a few hours. We want our part-timers to eventually drop other employment commitments and become full-time employees. It is usually wise to convert your independent contractors to employees when they do not have another employer.
And of course once the organization becomes a corporation, the owner then becomes an employee of his or her own corporation. At that point the owner may consider using a payroll service that will help with managing payroll deadlines and processes and the taxes required.
Other things to think about
Independent contractors often view their relationship to the organization quite differently from regular W-2 employees. They see themselves as the self-employed. The practice “owner” is a landlord and not a boss. They are merely renters of space. And of course that may be exactly the way the owner sees the arrangement as well. If so, then all is well. But if not, then there may be tension. The owner’s vision makes a big difference in these decisions.
If you anticipate growing to where multiple full-time employees regularly work together toward common goals, you may want to bypass the independent contractor phase altogether. Hire people as employees right from the first. The more active you intend to be as a manager, the more you will want to hire people as regular employees.
The change from one to the other
When I began, my first employees where independent contractors. We then grew to where everyone dropped other employment and switched to working full time with us. At that point, we decided to convert all to regular employees. We worked with our accountant to convert the percentages we paid people to be roughly equivalent. Why was this necessary?
We explained the financial differences between being paid as an independent contractor versus an W-2 employee in this way:
Clinical staff pay is based on the amount of gross receipts collected each month; this becomes the basis for the next month’s paychecks on the 15th and the 30th.
To compare our system to one that treats you as an independent contractor (IC), add about 10 percent to the out-of-pocket costs of the IC package. This is so because independent contractor taxes are handled differently from a W-2 employee’s. An independent contractor must pay 100 percent of the social security and medicare taxes, and that adds 7.65 percent to the IC’s tax bill every year. As your employer, the company (CCC) pays the 7.65 percent plus some other taxes; CCC also offers employees a 3 percent match for their retirement funds. This plus the other benefits CCC offers is more than a 10 percent value over what an independent contractor would pay.
In my experience, the emotional transition to a W-2 employee was difficult for some. Some were unable to adjust. They left within a year or two. Accepting that they now had a boss was just to much. However, for most of our clinicians, they transitioned well. And many came liked it very much. It shifted responsibility for some taxes to the company.
Use your accountant to help you with these calculations. Mistakes can hurt the company and it’s employees.