If you are running a small business or franchise, you may have a diverse team of people who support your business in a variety of ways. When tax season rolls around, it is critical that you categorize these people correctly.
The penalties for miscategorizing people whom you pay can be steep. You may get audited, then be subject to fines and penalties that endanger your business.
It’s best to know at the beginning of a relationship whether a person who works for you will be a salesperson (an independent contractor), or an employee.
You should also periodically assess these relationships every few years because an employee can turn into an independent contractor over time and a contractor can evolve into an employee.
Here are ten facts you need to consider about the salesperson vs. contractor difference, knowing how to tell them apart, and how to classify someone who works for you so you do not get into trouble with the IRS.
- An Employee Gets Taxes Withheld
- Salary or Commission
- Control or Autonomy
- The Boss- Worker Relationship
- Training Is Also a Factor
- Employees Are Covered By Federal Employment Laws
- Full-Time?
- On the Premises?
- Reporting and Reviews
- A Sales Rep is Not a Sales Agent
1. An Employee Gets Taxes Withheld
Once you start paying people for doing business with you, you need to learn the difference between an employee and a sales contractor.
An employer must withhold and/or pay income taxes, Social Security and Medicare taxes, and unemployment taxes on wages paid to an employee, and pay the proper amounts to the IRS.
These payments appear itemized on paychecks and final W2 statements.
An employer does not withhold these taxes from the payments made to an independent contractor or salesperson. The individual contractor is responsible for paying his or her own taxes.
Because an employer is not obligated to pay these items for independent contractors, he may be tempted to call everyone who works for him as an independent contractor. If everyone just conducts sales of his products and gets paid when they sell, then they are a contractor, right?
No, it’s not that simple.
Just calling someone a contractor does not make them so. And withholding taxes and benefits from someone’s paycheck does not automatically make them an independent contractor either.
It also does not absolve the employer from responsibility for paying those costs if they are indeed employees.
Not withholding from people’s pay does not necessarily mean they are not employees.
2. Salary or Commission
The IRS and other authorities will examine several criteria when determining whether someone is a salesperson or contractor. One of those is the manner of payment.
An employee usually gets paid a salary. They may get a paycheck every two weeks, or once per month. If they get paid the same amount every check, it’s likely that they are an employee.
However, hourly workers can also be employees. They may not get paid the same amount every pay period if they work irregular hours. However, if they receive a regular wage, they are probably employees.
On the other hand, contractors get paid by the project. If they are a salesperson, they may get paid in commission when they make a sale. If the person is getting paid on the basis of these events instead of on a regular continuing basis, it is likely that this is a contractor.
Because salespeople often have arrangements where they are given advances or “draws” on future commissions, it can get a little confusing.
The IRS has issued a 20-factor guidance letter to explain the many factors that go into deciding whether someone should be considered an employee or salesperson for taxation purposes.
In one case where salesmen were paid by commission but could take a draw against next week’s commission, a court found that paying a commission indicated independent contractor status, but allowing someone to take a draw pointed more towards their status as an employee.
Providing a company car, paying for expenses or offering a per diem amount to salesmen were also indicators of an employee relationship.
3. Control or Autonomy
Another difference between an employee and an independent contractor is how much control they have over their workday.
Do they make their own hours? Can they decide when, where and how they will get the job done?
If you tell someone to go out and sell twenty appliances, but you do not tell him how to do it, he is probably your contractor. On the other hand, if you tell someone they must sit in your office and make phone calls every day from 9 am to 5 pm, that looks like they’re an employee.
Contractors work on a project by project basis. They presumably know how to do what you are paying them to do. They don’t need any extra training.
Contractors or salespeople can decline an assignment. That makes them different from employees, who risk termination if they say no to the boss!
Sales contractors can work for many different companies. They may file as self-employed and even have their own business to which you issue a check.
If you hire salespeople and they need to drive for work, ask them to drive their own cars instead of lending them yours if you don’t want to withhold their taxes.
Instead of reimbursing them for gas and other expenses, they should charge you a fee that includes all that.
Contractors can even pay someone else to get the job done if they like.
If you want to have more control over what and how your worker earns his pay from you, you may prefer having an employee. You will be obliged to pay his payroll taxes, offer overtime, and give him paid time off. You will also gain the right to tell him how you want the job done.
4. The Boss – Worker Relationship
If you are accused of miscategorizing a worker, know that the agency involved will carefully look at the nature of your relationship.
Does the worker in question have a contract? Does she supervise other staff? Do you rely on her for a variety of things?
If the worker is really an integral part of the company, they may be deemed an employee.
Other factors which contribute to the appearance of someone as an employee include company clothing or name tag, whether they are on your website, and whether they have a title with the company.
That demonstrates that the person has a permanent and integral relationship with the company instead of being temporary and transient.
Although you can fire a contractor/salesperson or an employee at will, if you terminate a contractor before the project is over you may still have to pay them.
The flip side to that is that contractors can’t quit in the middle of a project without incurring liability for nonperformance.
5. Training Is Also a Factor
Contractors are usually considered experts: you hire them to get the job done because they hit the ground running.
Employees are given training and are expected to commit themselves to the company for an extended period of time. Depending on your business model, you may want to encourage retention by offering professional development and other incentives for people to stay with you for a long time.
On the other hand, if your goal is to move product, you may just want a contractor who knows how to sell and who you don’t have to spend a lot of time training.
An important difference between a salesperson and an employee is that you are expected to provide ongoing training to an employee.
6. Employees Are Covered By Federal Employment Laws
If you have employees, you have to make sure that you comply with applicable state and federal employment laws. You cannot discriminate based on any protected category like race, gender or age. You have to make sure you obey all relevant work safety regulations.
Federal employment and labor laws under statutes like OSHA and ADA do not apply if you only use independent contractors. However, people can still sue you under different statutes if they are injured during the course of business with you.
Hiring independent salespeople, only, does not absolve you from your basic obligations to maintain a safe and discrimination-free workplace.
7. Full-Time?
If you need someone to work with you full-time, you probably need an employee. If someone works from 9 am to 5 pm for you five days per week, they are likely to be seen as an employee.
A contractor may not need to work a full work-day to complete the project for which you hired her. How much time she spends is up to her.
Some salespeople prefer the flexibility that a contracting job permits. Instead of punching a clock, they can get their projects done whenever they like: the middle of the night, even!
8. On the Premises?
Do you provide the individual with an office or desk in your workplace? Do you provide secretarial support, IT equipment, or a receptionist? Employees benefit from all of the advantages of working in an office.
You are also responsible for maintaining a safe and healthy work environment if you maintain an office or working space where employees will be working. By having that consistent access to them, you incur the responsibility to take care of them by obeying OSHA rules and paying their Medicare taxes.
Independent contractors usually work remotely and may meet with you in person rarely if ever. They are responsible for their own computers, telephones, and other office equipment.
9. Reporting and Reviews
Another way to determine the difference between an employee and a salesperson is how they report to the boss. Usually, a sales contractor is responsible for getting the numbers: they need to sell the number of items for which they were contracted.
An employee has to report to the employer on a wider range of activities. In addition to the results of their work, they may need to report on other staff results and the environment in the workplace.
They need to check in and check out.
An employee also is more likely to receive regular reviews.
In an employee-employer relationship, the employer is expected to give annual or semi-annual feedback on how the employee is doing and ways to improve. Results of these reviews may lead to increased compensation.
If you are working with an independent contractor, you are not obligated to give feedback on their project. If you don’t like how they performed, you have the option to not use them again!
10. A Sales Rep is Not a Sales Agent
A sales agent is an independent contractor.
They earn a percentage of what they sell or a commission based on sales. It is in the best interest of the sales agent to get the highest amount possible because the sales agent’s pay is directly related to how much they sell for the client.
A sales rep is probably an employee. She works for the company and acts for the benefit of the company. She is responsible for building the business by selling the employer’s products or services to other companies or individuals.
The sales rep is usually paid a salary with a commission or bonus based on how many sales she made.
Sales reps usually work on the company premises. with access to the management team. They are a part of the company’s everyday interactions and functions. They are usually deemed employees.
Salespeople or agents work in the field. The more they sell, the more they make.
Sales Contractor or Employee: Knowing the Difference, Knowing What’s Best for You
Many different considerations go into the decision of whether to work with independent contractors or employees.
If you need consistent support, if you want to build an organization with a team of loyal staff members, if you are willing to invest in people so that they stay with you for the long term, then you may find that employees are what you need. In return for paying for FICA, you hope to gain people committed to you and your vision for your company.
If you do not have a big budget to invest in people long term and you have a lot of product to move, hiring independent contractors or salespeople may be the right choice for you. You want experienced and independent workers who know what they are doing and will help you get rolling without a lot of extra start-up costs.
With employees and salespeople, it is all about knowing the difference; knowing what is best for you then is easy.
For more information on hiring, taxation and financial strategies for your small and large business enterprises, contact us.
