Pass Through Income Deduction

After a very busy January, accounting professionals have the classification of independent contractors or employees on their minds. Specifically, assisting businesses with properly classifying service providers and the appropriate documentation to collect at the time of hire. Proper classification is vital, as it protects both the business and the provider of the services.

Unfortunately, there is no single definition for an employer-employee versus independent contractor relationship, rather it depends on the circumstances of the situation. Below is a chart from the US Department of Labor that shows a summary of the guidelines for determining the appropriate classification.

EmployeeIndependent Contractor
Working for someone else’s businessRunning their own business
Paid hourly, salary, or by piece ratePaid upon completion of project
Uses employer’s materials, tools, and equipmentProvides own materials, tools, and equipment
Typically works for one employerWorks with multiple clients
Continuing relationship with employerTemporary relationship until project completed
Employer decides when and how the work will be performedDecides when and how they will perform the work
Employer assigns the work to be performedDecides what work they will do
Source: https://www.dol.gov/agencies/whd/flsa/misclassification

Essentially: is the person dependent upon the business economically and for work assignments and provision of tools, in an ongoing relationship with the business in which they are instructed when and how to perform the work? Or do they work with multiple clients, on particular projects for which the how and when is at their discretion and the provision of tools and materials is at their expense, and for which they get paid once the job is done?

Once the proper classification is determined, it’s important to collect the associated documents.

For independent contractors:

  • W-9 to provide their Tax ID, address, and entity status
  • Proof of workers compensation insurance or an exemption certificate
  • Proof of liability insurance coverage

For an employee:

  • W-4
  • A state version of the W-4 if applicable
  • I-9 with acceptable documents proving eligibility to work
  • Other typical documents:
    • A hire form with date, wage, FT vs PT status, exempt vs non-exempt status, and benefits
    • Personnel manual
    • Employment agreement
    • Direct deposit information
    • Any special notes such as emergency contacts or special employment accommodations.

Following these guidelines at the time that services are engaged is the key to a calm and smooth January and a happy accountant! If you have questions regarding the differences between employees and independent contractors, please contact the AZ Team.

This article was written by Amy Cristaldi, AZ Leverage Professional in our Missoula office.

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