Payroll is expensive, confusing, and expensive. But unfortunately, it is a necessary facet of business for almost every industry and organization type. Use the following evaluation tactics in order to assess if you are ready to start putting employees on the books.
Important Things to Know
- Entity Type
- What type of organization are you? The concepts for payroll are going to be different for Sole Proprietors, Partnerships, and Corporations.
- Ownership Relationship
- Owners, Partners, Shareholders, and Sole Proprietors generally have the most flexibility when it comes to determining payroll, since they have other options to access money from the organization.
- Stage of Start-up
- Newer businesses need to be more deliberate in their payroll approach, as payroll is almost always a substantial cost of operations.
Employee vs Employer
The general rule is that payroll is Good for Employees, and Bad for Employers. Once an employee is put on payroll, they are guaranteed a more consistent payment schedule, the organizational liability shield, as well as access to appropriate benefits and a structured employment agreement. Benefits are becoming a larger and more important factor in the employment picture as the costs of healthcare increase and governments mandates become mainstream. The expenses of payroll and benefits, plus human resources and other employee management requirements can be devastating if not handled properly.
Independent Contractor vs Employee
Employers generally want independent contractors, since they get paid a flat rate and are not eligible for benefits. However, the Employer’s control over independent contractor is much less than that over an employee, including behavioral, financial, and relationship components.
The IRS uses a non-statistical approach to determine employee vs independent contractor classification. In other words, if it walks like a duck, swims like a duck, and quacks like a duck, it’s probably a duck. We highly encourage all business owners to review the IRS’s website and their general guidance for determining employee classification.
So when do you need to start formal payroll procedures? The answer is….. the last moment possible. Try to avoid jumping into the employer realm too early, or else you will immediately be on the hook for unemployment for terminated employees that have to be laid off, as well as payroll tax filings and payment requirements being triggered.
If the only employees of the organization are owners, partners, or the sole proprietor then you can kick the payroll can down the road a little. Shareholders, Partners and Sole Proprietors can be paid through “distributions”, which is a non-payroll payment that is purely a portion of net income paid out. These payments affect cash flow and are non-deductible for tax purposes, but you avoid the basic payroll taxes of 13% on top of the income tax. The only caveat is for shareholders of S Corporations, who must to maintain a level of “reasonable compensation” in order to avoid payroll tax scrutiny. (The key is that reasonable compensation for start-ups are normally very low, since it is reasonable to limit compensation when the business is not established) Likewise, owners of C Corporations (Regular Corporations that did not elect S status) have a web of taxation concerns that need to be considered when addressing payroll.
Unfortunately, bringing an employee on the books is not as simple as cutting them a regular check. Payroll also includes Federal and State tax filings, annual Social Security and W-2 filing requirements, as well as tax withholding and I-9 immigration obligations. We highly recommend that you consult a business or taxation professional when you determine the need for formal payroll for your organization.
As you will find with most of our advice, the best thing you can do is consult a CPA for your own specific situation. The important thing to remember is to avoid jumping the gun when it comes to starting payroll, or be ready to start paying a consistent and substantial cost for everything from wages to payroll tax preparation to employee benefits.
Consider the aspects of payroll from the perspective of employees, independent contracts, as well as from your business ownership perspective. The longer that you can justify and maintain workers as independent contractors, the more flexibility and savings there are. As soon as the relationship starts to quack like an employee, be ready to make the change to full employment status.
For further questions, please leave comments to this post or email questions to Justin and Chris @Universalbookkeeper.com