Responsibilities Of An Employer (With Video)
Responsibilities Of An Employer: What You Should Know About Small Business Hiring
Welcome to part 8 of our 10 part series, Idea to Income, where I interview Ted Lavin, President of SD Biz Pros. In this episode, Ted explains the responsibilities of an employer hiring employees for their business.
Two of the major challenges new owners face come from human resources and payroll. Best practices from a compliance standpoint, and how do you effectively pay for this new help?
This video will arm you with helpful foundational information for your employee onboarding.
We’ll review:
- The ABC test to IC vs W-2 workers
- The tax implications of a W-2 worker
- Responsibilities beyond taxes
- The employer handbook
We cover a lot and hope you enjoy our discussion!
Contractor vs. Full Time Employee
Normally when someone starts a company, it’s natural that they hire friends and family first. But it’s important to understand that to the government, they’re not just family, they’re employees. The government wants their taxes and will still require worker’s compensation on them (we discussed workers’ comp in more detail in episode 4). So whether you are hiring friends and family, or moving outside that so-called “circle of influence”, one of the responsibilities of an employer is deciding: will your new help be classified as W-2 employees, or 1099 independent contractors?
In the state of California, the government uses the ABC rule, to determine which classification to use. If you answer yes to all three of the following questions, they are a 1099 independent contractor:
A. “The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
B. “The person performs work that is outside the usual course of the hiring entity’s business.”
C. “The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.”
This may sound a little confusing at first, but an example should help:
Example: A carpenter vs. a web developer working for the same construction company
A construction company hires a carpenter and wants to classify him as a 1099 independent contractor.
Let’s go through the ABC test to check the appropriateness of their decision.
1. “The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
No. The carpenter likely has a strict schedule they need to follow and will be receiving direct supervision or direction from the company on the work to be performed.
2. “The person performs work that is outside the usual course of the hiring entity’s business.”
No. They’re in construction, the construction company builds things and carpenters help make that happen. This work falls in the normal course of business operations.
3. “The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.”
Probably no. They typically work with other people on a project.
Let’s say this construction company hires a web developer. Should she be a 1099 contractor?
1. “The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
Yes. The web developer can come and go as they please. Typically, they receive a completion deadline but can work their own hours to fulfill their commitment.
2. “The person performs work that is outside the usual course of the hiring entity’s business.”
Yes. They do web design. Not construction.
3. “The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.”
A web developer is typically an independent occupation.
The Impact of Taxes
Why does it matter whether you classify a worker as a W-2 employee or a 1099 contractor?
One of the responsibilities of an employer is to pay taxes on behalf of their W-2 employees. You do not have this responsibility for 1099 contractors. These tax savings can be enormous. Therefore, many owners try to use 1099 contractors to avoid payroll taxes if they can, which is a major reason the ABC test was developed.
You are required to pay the following taxes for your W-2 employees:
FICA
Made up of social security and Medicare equals 7.65%. These percentages are set by the government. Social security is 6.2% and Medicare is 1.45%.
Social security tax is paid on the first $137,700 (for 2020) of wages. This equates to a maximum tax of $8,537.40/year. The Medicare tax does not have a wage cap.
Unemployment
For federal and the state. Before your eyes pop out at these percentages, it is important to know you only pay these taxes on the first $7,000 of wages.
Federal is 6%. This equates to a maximum tax of $420/year.
Then there’s the state. When you registered as a new company in California you received your EDD number or FUTA number. They assign you 3.5% for state unemployment tax and then reevaluate you in three years. If you haven’t had unemployment claims against your business your tax will decrease, and the inverse if you have had claims. If there’s a good reason why you let someone go, you can fight their submission so they don’t get unemployment and claim against you. So, if you have people that are filing against you inappropriately, there’s a court and a hearing that can get the claim excused. If you do get justified claims against you, the maximum California state unemployment can increase to is 6.2%.
This means in addition to paying your W-2 employee their normal wages, you must also pay these portions of tax on their behalf.
For 1099 contractors, the only thing you need to do is file a 1099 form if you pay them over $600/year. So you can quickly see why many owners hope their workers pass the ABC test. While trying to use 1099 contractors to avoid payroll taxes may seem appealing to your bottom line, recognize the costs and penalties associated with misclassifying workers are very real. You could face back taxes and penalties for any misclassification that could cripple your business later. Take the ABC test seriously and be sure to classify your workers correctly.
Evaluating Payroll Providers
Once you’ve determined your worker’s classification, one of your main responsibilities as an employer is to pay them!
Typically you’ll want to leverage a payroll company. The options range from the do it yourself approach with the support of Gusto, to working with the juggernaut ADP, and plenty of others in between. Which option you choose will typically depend on your number of employees and the support you need.
In addition to getting the payroll taxes right, you’ll also have filings and administrative requirements these companies can support you with. There’s a lot that you need to know, and unfortunately, if you’re not doing it right, not knowing the law is not an excuse.
Workers’ Compensation
Worker’s comp is the law. When you have employees, you have to have it. There are a lot of carriers and brokers like Ted who can search the market for competitive quotes.
Recall that with the taxes we discussed, your payment is fixed and dictated by the government. With worker’s comp, you can actually shop around for better rates.
Worker’s Comp Codes
It doesn’t matter if it’s a service industry or product, there’s a worker’s compensation codes affiliated with whatever you do. Those codes determine the cost associated with coverage and will increase with the riskiness of a job. It’s fair to assume a roofer will have a higher workers’ compensation premium than an office secretary.
Also, know that even some jobs will have dual codes. For example if you have a roofer making under $25 an hour, you pay more in worker’s compensation than if you have a roofer making 26 or above. This is because if they’re going to get that amount of money, they’re likely more experienced and therefore their chance of getting hurt less. You can also do things to help yourself, like have a safety inspection where OSHA will come out and look over your business. Many of the carriers themselves have people that will come out and give you recommendations on how you can drive that cost lower.
One of your responsibilities as an employer is to ensure you have proper safety measures in place. Not only is this the right way to operate, but it will also help your bottom line by driving down your workers’ comp premiums.
The worst thing related to workers’ comp you can do is go without protection.
The second worst thing is to miss payments. If you get dropped, it’s really hard to get coverage back again.
Employee Handbook
The number one thing Ted recommends for quality HR oversight is an employee handbook. Many third parties offer these handbooks for purchase. But be careful, you usually get exactly what you pay for.
Ted refers his clients to his employment attorney. The attorney puts the handbook together and it provides a helpful resource. It’s similar to insurance as a well drafted handbook shows any opposing council you take these parts of your responsibilities as an employer seriously.
Conclusion
Wow, a huge thank you to Ted Lavin of SD biz pros. Ted provided a lot of information when it comes to hiring an employee. Specifically, I think it’s important we always remember to pay your taxes and develop HR policies that help your company thrive.
Remember, this series is all about taking action.
As you think about hiring, remember to evaluate:
- The ABC Test
- The true cost of a W-2 worker
- Which payroll provider is right for you
- Establishing an employee handbook
If you’d like help evaluating your company’s compensation strategy, be sure to contact us. We can analyze your current structure and make recommendations that align incentives, improve profitability and create a win-win system for you and your employees.
To follow along with future Idea to Income episodes, please be sure to subscribe to our Youtube series and sign up for our free email list to receive helpful financial information straight to your inbox.
