What if misclassifying your team could cost you thousands in back taxes, penalties, and missed benefits? Most business owners don’t realize how risky it can be to pay someone as a contractor when they really should be an employee.
In this episode, Danielle Hayden, reformed corporate CFO and CEO of Kickstart Accounting, Inc., simplifies the IRS classification rules into a 3-step framework that helps you confidently decide whether your next hire or current team should be a contractor or employee, and when it might be time to make a change.
Key Takeaways:
- Know the 3 Keys of Classification: These are the factors the IRS uses to determine if someone should be classified as an employee or contractor.
- Behavioral Control – Who decides how and when the work gets done?
- Financial Control – Who provides the equipment and sets the pay rate?
- Relationship – Is this a short-term project or an ongoing partnership?
- A Signed Contract Doesn’t Override Your Day-to-Day Working Relationship: If you control how, when, and with what tools someone works, they’re likely an employee, no matter what the contract says.
- Your Team Structure Will Evolve as Your Business Grows: It’s normal to start with contractors and transition to employees as you establish systems, brand standards, and long-term goals.
- Don’t Forget the Tax Implications: Contractors complete a W9 and handle their own taxes (including the employer portion). Employees go on payroll, and you, the business owner, take on that responsibility.
- Trust Your Gut and Your “Auditor Test”: If you couldn’t confidently explain to an auditor why someone is a contractor, it’s probably time to make them an employee.
Topics Discussed:
(00:00) Intro: The Costly Risks of Misclassifying Your Team + The 3 Key Factors the IRS Uses
(02:28) Step 1: Behavioral Control – Who’s in Charge of the How and When?
(02:56) Step 2: Financial Control – Who Sets the Pay and Provides the Tools?
(03:24) Step 3: Relationship – Short-Term Project or Long-Term Partnership?
(04:13) Why a Signed Agreement Isn’t Enough If You’re Relationship Says Otherwise
(04:44) Trusting Your Gut: The “Auditor Test” for Classification Decisions
(05:14) How Your Hiring Strategy Evolves as Your Business Grows
(08:13) Tax Implications: W9s, 1099s, and Who’s Responsible for What
(09:58) Resources on Hiring and Payroll for Business Owners from Kickstart Accounting, Inc.
(10:29) Quick Recap of 3-Step Framework + Danielle’s “Gut Check” Test Before Hiring
(11:06) Outro: Like, Share and Subscribe!
Related Episodes:
The Employee Expansion Blueprint: When It’s Time to Convert 1099 Contractors – Ep 120
Resources:
The Ultimate Small Business Hiring Guide: From Planning to Payroll, How To Build a Thriving Team
Book a Call with Kickstart Accounting, Inc.:
https://kickstartaccountinginc.com/book-a-call/
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Episode Transcript
00;00;00;00 - 00;00;34;17
Danielle Hayden
What if I told you that misclassifying your team could cost you thousands in back taxes, benefits, and penalties? Most business owners don't realize how dangerous it can be to hire someone as a contractor when they really should be an employee. In this episode, I'm giving you a simple three-step framework to know with confidence whether your next hire should be a contractor or employee, or if it's time to move your existing team from a contractor to an employee.
00;00;34;20 - 00;01;09;06
Danielle Hayden
You're listening to Business by The Books, the podcast that helps you, the business owner, understand your numbers so you can make confident and empowered decisions. I'm your host, Danielle Hayden, CPA, reformed Corporate CFO, and CEO of Kickstart Accounting, Inc. I've helped thousands of entrepreneurs navigate this exact decision. And today, I'm bringing that expertise straight to you. We'll start by breaking down the IRS guidelines into three easy to understand categories: behavioral control, financial control, and the nature of your relationship.
00;01;09;08 - 00;01;33;04
Danielle Hayden
Then I'll share a real client story that shows the risk of getting this wrong. And I'll walk you through how to apply this framework to your own business. One of my favorite ways that we have the opportunity to help our clients at Kickstart Accounting, Inc. is when they are hiring. This question is amazing: can I afford to hire and should I hire a contractor or an employee?
00;01;33;06 - 00;01;54;03
Danielle Hayden
So what I wanted to do today is give you a very simple framework to decide on whether or not they should be a contractor or an employee as you bring on this new team member. I had a client who came to us a few years ago, and during onboarding, she was being slapped with a penalties and fines for paying her team as a contractor.
00;01;54;03 - 00;02;21;16
Danielle Hayden
She was being sued for back benefits and back 401(k) contributions. You guys, the penalties are real if you, as a business owner, pay your team members as a contractor when they really should have been an employee. So I want you to have this simple framework to know when somebody should become an employee. So there's three things that the IRS has given us to determine this.
00;02;21;18 - 00;02;56;15
Danielle Hayden
First is behavioral control. Second is financial control. And the third is relationship. So what does that mean? When we think about behavioral control, when this new team member starts within your company, will they be following your standard operating procedures. Will you be controlling when they come to work? How they complete the work? Will you be giving them feedback on an ongoing basis to make sure that they're following your brand guidelines and the framework in which you want tasks completed?
00;02;56;17 - 00;03;24;26
Danielle Hayden
Next is financial control. Are you going to be providing a laptop to that team member, or are they going to be using their own personal computer, equipment, home office? And then who's setting the rates for pay in financial control? Is your contractor, is your team member going to set the rate and invoice you, or are you setting the rate and paying that team member on a consistent basis?
00;03;24;27 - 00;03;53;09
Danielle Hayden
Lastly is relationship. Do you have a agreement in place? And if this individual who you're hiring, if they have their own LLC, they're providing you with a contractor agreement, they are setting the price and invoicing you on a regular basis, and then they complete the work on their own personal laptop in a way that they choose, right? They're the expert. That is a contractor.
00;03;53;10 - 00;04;23;00
Danielle Hayden
If this team member does not have a contractor agreement, if they are an individual and not an LLC or a corporation, are you going to be in a relationship with them for a short-term project basis, or are you going to be in a long-term, day-to-day relationship with that person? So to clarify, when we think about behavioral, financial and relationship control, the working relationship with this team member is going to mean more than an agreement.
00;04;23;03 - 00;04;44;05
Danielle Hayden
So just because you sign a contract or agreement, but if you are providing a laptop, you are setting the rate of pay and how many hours a team member works, you're providing the brand guidelines and standard operating procedures, then it's not going to matter that you have a contract or an agreement in place because you're working relationship with them is set up like an employee.
00;04;44;07 - 00;05;14;24
Danielle Hayden
Now, as a business owner, I think that we're able to use our gut more often than not when we're making these decisions. So I want you to pretend like you are sitting across from the auditor, and I want you to make your argument as to why you're paying this person as a contractor or an employee. If you can't, with good faith and with a good feeling in your gut, sit and make an argument to an auditor about why they should be a contractor, then it's time to move our contractors to an employee.
00;05;14;25 - 00;05;38;24
Danielle Hayden
Now, I want to say that it is okay to change over time. We have clients who have gone through these phases. You know, they start their business as a solo entrepreneur, and as their business grows, they really start to form a small business, creating standard operating procedures and brand guidelines. But as we're doing that, often we need contractors as part of our business.
00;05;38;27 - 00;06;03;20
Danielle Hayden
And so it's very normal as you move from entrepreneur to small business owner, that you have a set of contractors in your business. Now generally contractors, they're going to be people who they're experts in their industry. You don't have to give them feedback or guidelines on how to perform tasks. They already have their equipment and they're operating as their own business.
00;06;03;22 - 00;06;33;22
Danielle Hayden
They're able to take their own tax deductions and so they are setting the terms and price that you as their client are going to pay. And then they provide a contractor agreement with their LLC to your business. And we're able to feel good about that type of contractor relationship. It's okay to change as we move and grow as a small business and you grow in your CEO journey.
00;06;33;28 - 00;07;05;14
Danielle Hayden
There's going to be a time where you want control, and you want to be able to set the parameters for your brand. I know that this happened for me at Kickstart when we created our framework, our standard operating procedures, and the way that we do business with our clients. That's when everything changed for us. And I knew that I had behavioral control because when I have a team member who works at Kickstart Accounting, they are required to follow our standard operating procedures.
00;07;05;16 - 00;07;37;17
Danielle Hayden
Our clients receive the framework that has been proven to work, and I want every single team member to follow that framework. It took me time to create that framework and set that framework up, and so we might have started with contractors, but we only work with employees now that I have this established brand and control. In terms of financial control, as you grow as a CEO and mature in your journey, you are going to want to be able to set the rates and hours for your team members.
00;07;37;17 - 00;08;13;14
Danielle Hayden
You might have resistance towards paying for their laptop and equipment. However, you're going to want to be able to set the parameters for your relationship. And you guys, once you train somebody, I love that we have long-term employee relationships with our team here at Kickstart, and for us, it's really important to have those long-term relationships. So know and understand that as you grow from entrepreneur to small business owner to CEO, that who you need in your business is going to change.
00;08;13;15 - 00;08;41;04
Danielle Hayden
Now, I want to touch on the tax implications of both a contractor and an employee, so that you can communicate that to your new team member. So if you are hiring somebody who's going to be a contractor, you are required to collect a W9 form for that team member. The W9 is an information sheet so that you can complete and send them a 1099 at the end of the year.
00;08;41;06 - 00;09;10;17
Danielle Hayden
What's really important to communicate to this team member and to ensure that they know and understand, is that they are going to be required to pay the employer portion of the taxes. As an employee, you, the business owner, pay the employer portion of the employee's taxes. As a contractor, they are responsible for both the employee and the employer portion of their pay.
00;09;10;18 - 00;09;37;07
Danielle Hayden
This is really important because we want to set our contractors up for success. They need to be saving enough money. They should be saving 25% of their net income to be able to pay their own payroll taxes. Now, once you've moved somebody from a contractor to an employee, you, the business owner, are going to set them up on payroll and you are going to be paying the employer portion of their taxes.
00;09;37;10 - 00;10;04;10
Danielle Hayden
So as you communicate with your new team member, be sure that they understand what they are going to be responsible for and what you are going to be responsible for as the business owner and employer. Because this is an exciting time. I love being able to watch our clients grow and expand their team, expand their community. If you have any questions or you need a money team, go to KickstartAccountingInc.com.
00;10;04;10 - 00;10;28;20
Danielle Hayden
We would love the opportunity to partner with you and to be a resource for you. I'm going to drop several shows in the show notes. If you feel like you need more information on contractors and employees, we have done an entire series on what is a W9, what is a 1099, when to convert. So there will be additional resources in the show
00;10;28;20 - 00;10;58;04
Danielle Hayden
notes. Remember this three-step framework the next time you are hiring! Do you have behavioral control? Think standard operating procedures and brand guidelines. Do you have financial control? Are you providing the equipment and are you setting the rate of pay and when they get paid? And what is the nature of the relationship? Will this be a short-term project or will this be a long-term relationship?
00;10;58;05 - 00;11;27;08
Danielle Hayden
Present this to your money team or make-believe auditor to give yourself a thorough gut check. I hope you enjoyed today's episode of Business by The Books. Don't forget to hit like and subscribe! This is the number one way we can help other entrepreneurs find this podcast, because here at Kickstart Accounting, Inc., it is our mission to help entrepreneurs understand their numbers, get access to this information, and grow and thrive in their business.
00;11;27;08 - 00;11;49;05
Danielle Hayden
So please help me, help other entrepreneurs understand their numbers so they can finally grow and thrive.