Over the years, we’ve had clients who started their businesses based on an independent contractor model, and as their businesses evolved, they found that they needed to switch over to an employment model.
If not done properly, making this switch can come with some risks, so we advise clients to take care and to follow a detailed checklist in implementing this transition. Below are some of the key items we have our clients consider and address in making this transition:
1) Determine/understand financial impact of conversion.
Assess financial impact and feasibility of having employees. Specifically consider mandatory employer costs and other costs in making the switch to ensure it makes financial sense for both the employer, and the converted contractor. Mandatory employer costs include: net salary or hourly wage; federal income tax; social security and medicare taxes; federal unemployment tax; state unemployment tax; Worker’s Compensation; Paid Family & Medical Leave; Long-Term Care Tax (ESD); etc.
2) Determine conversion date.
Sometimes it will make sense to make the conversion as soon as possible, particularly if the contractor model presents legal or regulatory risks to your business. Other times it will be better to do so at the start of the calendar year e.g. to avoid giving a contractor a 1099 and W2 in the same year, and thus raising worker classification red flags with state or federal agencies.
3) Set up a checklist to onboard employees and collect necessary documents.
This will include: collecting necessary forms and employment information (e.g. Form W-4, Form I-9; social security information); reporting new hires to the necessary agencies; setting up payroll/direct deposit; setting up personnel files, etc.
4) Obtain an Employer Identification Number (EIN).
You may already have an EIN. If you don’t already have an EIN, as an employer with employees, you will need one.
5) Update your Master Business License.
If you have not previously had employees, as an employer with employees, you will need to update your business license with Washington State Department of Revenue (DOR) to reflect that you are hiring employees.
6) Enroll in EFTPS.
Enroll in EFTPS if you’re not already enrolled. All businesses receiving a new EIN (Employer Identification Number) are pre-enrolled in the Electronic Federal Tax Payment System (EFTPS). The Electronic Federal Tax Payment System (EFTPS) tax payment service is provided free by the U.S. Department of the Treasury. After you’ve enrolled and received your credentials, you can pay any tax due to the Internal Revenue Service (IRS) using this system.
7) Implement time-keeping system.
If you have not been tracking contractors’ time and most businesses have not, you will need to implement a time-keeping system. L&I has sample timesheets that will suffice.
8) Decide on Payroll System and/or Payroll Service.
Decide on a payroll software or payroll service, which will make the tax and withholding requirements and payments easy to manage by doing much of the work for you. If you don’t have a bookkeeper experienced with processing payroll, we recommend finding such a bookkeeper, or using a payroll service.
9) Retroactively account for 1099 Payments.
To avoid having to issue both 1099s and W2s to the same employee for the year in which the conversion occurred, you may be able to work with bookkeeper to classify and treat 1099 payments as W2 payments.
10) Employer Tax Responsibilities.
As an Employer, you will have tax withholding and withholding responsibilities on your employees. These will include:
a. Federal Income Tax;
b. Social Security & Medicare Taxes (FICA);
c. Federal Unemployment Taxes (FUTA);
d. State Unemployment Taxes (ESD);
e. Workers’ Compensation Insurance (L&I);
f. Paid Family & Medical Leave (ESD);
g. Long-Term Care Tax (ESD).
These withholding and reporting obligations will be required with each paycheck issued and on a quarterly basis.
11) Adhere to Notice Posting Responsibilities.
The government requires employers to post notices providing information on worker rights for their employees. Required and recommended posting requirements can be found here: https://www.lni.wa.gov/forms-publications/f101-054-000.pdf
12) Prepare employment agreement, and/or employee handbook
If employment agreements and handbooks are helpful and/or necessary, draft employment contract, and/or handbook outlining policies and expectations.
Please note that the above is just an overview of the items to address in the making this transition, and it is not intended to be an exhaustive discussion of the issue. So do consult with experienced counsel regarding your particular circumstances before making this transition.