140. Employee or Contractor? What you need to know about taxes & the IRS crackdown on proper classification

In this episode of Keep More Money, Kimberly Tara, CPA, CTC addresses the challenges women business owners face with taxes and business finances while sharing her own experiences of balancing a growing business with family life. Kimberly discusses the critical differences between W2 employees and 1099 contractors, highlighting the tax implications and IRS rules associated with each. She emphasizes the importance of proactive tax strategy and proper classification to avoid costly mistakes. The episode aims to empower business owners and freelancers to take control of their financial decisions, minimize tax burdens, and build lasting wealth.

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Connect with Kimberly on Instagram: @kimberlytaracpa

Transcript

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Welcome to Keep More Money, the podcast for profitable women business owners who are tired of overpaying in taxes and tired of chasing down their CPA, deferring to someone else for every financial decision and getting hit with surprise tax bills every April. If you've ever felt like you'll never truly get on top of your business finances. This show is for you. I'm Kimberly Tara, CPA, certified tax coach, multi-business owner and Mama four Littles. With over a decade of experience and more than 15 million saved for my clients, my mission is to educate and empower women just like you to keep more of their money, reduce financial stress, and create lasting wealth. Taxes suck, but they don't have to hold you back. I'll show you how to make tax strategy simple, fun and easy to understand. You've worked hard for your success, and now it's time to keep more of it. Let's dive in. Hello. Hello. So you might have noticed it's been a few weeks since the last episode and no, you didn't miss anything. There were no technology issues. There really has just been. A bit of a gap. I wish I could say I was off on some Grand World tour or doing something glamorous, but honestly it's just been life, real life. The kind of messy, busy, unpredictable life that happens when you've got four kids, a business and what feels like a million moving pieces. have you ever been there too and. Right now, I mean literally moving because we bought a house, which sounds exciting and it is. but when you do it for the fifth time. It loses its luster and it just becomes annoying Paperwork. And if you've ever moved with kids, oh man, you know, it's a whole different level of chaos because let me tell you, kids come with so much stuff, the toys, the clothes, shoes, books. Oh my goodness. We had three moving boxes full of books, and we had already purged from the move from Louisiana to North Carolina and. You're trying to box up all the art projects from preschool that you're just like, why am I saving all of this stuff? And none of my kids are quite old enough to be truly helpful yet, like my dream of handing a child a tape gun and saying, Hey, go pack up your room. Yeah, like that's not happening. Instead, they're playing with the Legos that I ask them to pack up, or they're yelling out to me, mom, I can't find Do Doll, which is our five year old's favorite stuffy. So moving was an event to say the least. I'm so grateful my team came out here and helped and we were able to really strategize because, unlike my kids who weren't helpful, my team was super helpful and we could put things in boxes while actually talking at the same time. so if you've ever been through a move. Period. But especially with children, you know that everything else like comes to a halt because the house hunt, the packing, the paperwork, the unpacking the lender, it becomes a full-time job. And so I think this is extra true if you're a parent trying to minimize the chaos in your kids' lives, right? You're trying to get. Things, you're trying to wait until the last minute to pack them up. You're trying to get things unpacked as quickly as possible because I didn't want them, I wanted them to feel a sense of normalcy. so on top of running the firm, keeping up with client work, being a mom, at some point, something's gotta give. And for me that something was marketing and unfortunately. This podcast, I've always been upfront with you that I don't really, I don't schedule out our newsletters. I don't schedule out our podcast I want to be providing you with information and education that is in real time. I want to truly connect with you. because I don't do that so far in advance, I don't do this because I'm marketing. I do this because I truly believe in. The knowledge that I'm sharing with you, when things like this happen, sometimes I do have to hit pause and I actually made the decision to hit pause on the firm's marketing efforts, a little while back. And it's not because I don't believe in showing up or staying consistent, I do, but. Sometimes the most strategic move you can make is to just stop. Just pause, right? And I think as business owners, we're conditioned to believe that if we're not constantly visible, we're falling behind. if you're not posting, emailing, launching, then you're doing something wrong. And I've been in business long enough now to know that that's just not true. That sometimes you need to step back and look at what are the things that are actually moving the needle. And what's just noise, and that's really what this pause has been for me, somewhat of a reset. It actually started back at my Nantucket retreat, at the end of September. You can go listen to all of that in episode 1 38, but I came back from that trip with such a strong desire to just do less, and not in a lazy way, but in a really intentional way. I think that the story we tell ourselves as high achievers. That it is lazy instead of strategic. so for me, this looks like doing less of the things that drain my energy. Less chasing of vanity metrics. Like, oh, our firm hit a certain number in gross revenue this quarter or this year when what I really care about is profitability, sustainability, and exceptional client service. because let's be real gross revenue. It looks good on paper. It's flashy. It's the numbers you see posted online, but gross revenue doesn't pay the bills. It doesn't buy back your time. It doesn't let you take a real break when you need one. Your profitability does. And having a firm that sort of grows itself because even though we've been taking a hiatus from marketing for the last month, we've signed. six new clients, right? and we have more coming in the month here. The reality is that growing, quote unquote doesn't always fit your season of, life. And my life comes first, not the other way around. It didn't always used to be that way, but for now, that is very much the focus because what is the point of growing this business if I'm stressed out and miserable all the time? So instead of trying to do. All the things, the social media, the podcast, the videos, the newsletters being reactive. In our tech woes and whatnot, I decided to focus on what actually matters most, and that's serving our current clients really well. Sending out our weekly newsletter because it has exceptional open reads and responses, and I hear all the time how. Much women love it tightening up our systems, our technology, connecting one-on-one with new referrals via email or Instagram dms because they're reaching out and making sure the business I've built actually works for me and not the other way around. And this decision, honestly, feels so good. I've been calmer, happier, also scared, right? Because as a business owner it always feels weird to step off the hamster wheel to see other people still putting their foot down on the gas. But it really feels good because it's in alignment with, me and. I talk about this with our clients all the time, right? That just because something's working doesn't mean it's right, or doesn't mean it's right for right now. sometimes you outgrow certain strategies or your priority shift or life demands a little more of you in one season than another. And this season, for me, it's about simplifying, focusing on the things that move the business forward, serving our clients really well. Being there for my family and letting go of the rest, even if it's really hard and uncomfortable, I think that's something a lot of us don't give ourselves enough permission to do, right? You probably love the idea of balance and boundaries, but then the minute you're faced with a choice too, actually slow down. You panic. You think slowing down means slipping, but I feel like that couldn't be further from the truth. I think that sometimes slowing down is the strategy. And this isn't the first time I've slowed down to speed up. I didn't think it'd happened again so quickly. But my personal life has thrown us a few curve balls. And our firm has been rapidly growing and I just simply refused to let our client experience suffer because of that. So taking a short pause was best for everyone. And what I've been trying to do since my retreat in Nantucket is focus on embracing. That shift both personally and professionally, trying my best to remember that the goal isn't to do more, it's to do what matters And what matters most right now is again, taking care of my clients, taking care of my family, and taking care of myself. So if you've been in a season like that, if you're in a season like that right now, because gosh, we're about to go into the holidays and the end of the year. It's a time of feeling extra stretched thin or like you can't possibly do one more thing. I want you to know it's okay to hit pause and that by doing that it doesn't mean you're failing. It means you're being smart. And the funny thing is that this decision to pause, to be like, to take a step back, for marketing, actually creates the mental space. I need to think about some bigger picture stuff again and. was getting so in the weeds and so I didn't feel like I was having that space for, really listening and hearing or having the best and most creative ideas for our clients. And that's the stuff that gets me fired up is to help you make smarter money moves to keep more of what you earn, to come up with really amazing podcast episodes. And One of the things that, when I've had a little bit of space, I'm like, oh my goodness, I hear the same thing coming up in conversation with prospective clients again and again. And that is the confusion around W twos and 10 90 nines, I swear those two little forms. And the type of income they represent to you cause so much drama and they're different, but they really do go together. They're like two sides of the same coin. So whether you're someone who's transitioned from a W2 job to 10 99 income, or you're a business owner trying to figure out whether to hire your next team member as an employee or a contractor, understanding how those two worlds work is so important in both of those instances. Because here's the thing, the IRS is cracking down hard on misclassification right now. what that means is like paying someone like a contractor, but they should really be an employee. And then there are major tax implications, not just for your business, but for you personally, depending on how you're being compensated. So in this episode, I wanna break it all down for you. We're gonna talk about what it really means to go from being a W2 earner to a 10 99 earner, how to make that transition smoothly, and then what you need to be thinking about from a tax strategy standpoint before this year ends. And then we'll flip it around and we'll look at it from the other side. And you're the one doing the hiring. What you need to know about the IRS rules, how to classify people correctly and what's at stake if you get it wrong. Because again, these two things. W twos and 10 90 nines employees, independent contractors, they always go together. You can't really talk about one without understanding the other. To be clear and compliant, you need to know the differences so that you're making the right decision. This is also a really good time to, work with someone who understands this and this is the world that they live in, so that you can have the type of support that you need. And real quick, one more.'cause I feel like I just kind of started, I was excited to jump into the content, but I just wanna say thank you. If you've been listening to the podcast for a while, if you follow me on Instagram, if you read the newsletters, thank you for sticking around during quiet stretches and understanding. Why they happen. I promise I haven't gone anywhere. It's just been one of those seasons where real life took center stage for a bit, I also think that's something worth normalizing too, right? That you don't have to be on all the time to be successful. You don't have to post every day or hustle nonstop to build a great business. You just have to keep showing up when it matters and trust that. The work you've done, the work that you are doing still counts even when you take a breather I just wanna make sure that I share that with you too, and I don't jump right back into this like, nothing's happened. Like, no, here's what's happened. And my business is still very successful. And I just always am so grateful that you're here. Okay, so let's start with. You the individual side of the equation, because I know a lot of you listening are in this exact spot. You used to have a W2 job. You've started getting 10 99 income. Maybe it's from consulting, freelancing, brand deals, side hustle. Those could be things like, new skin. They're like so many things. And I have these women come to me and they're like, oh. Oh, I, I didn't realize that that made me a business owner. Maybe you have a rental property or two, and so you're thinking to yourself, oh, cool, I'm making this money, but I don't know what it means for taxes.'cause gosh, I didn't even realize that I'm actually a business owner. And so here's the deal. When you're a W2 earner, your employer does everything for you. Taxes are automatically withheld from your paycheck. They're covering half of your Social Security and Medicare taxes. they might be offering benefits like health insurance, retirement. You get a nice clean W2 form at the end of the year that basically says, here's what you earned. Here's what you withheld. If that's all you have, you can plug it into TurboTax and you're done. But when you move into the 10 99 world, all of that disappears. There's no boss withholding your taxes. No one's matching your social security, no automatic paycheck deductions. You get your money and the IRS expects you to set aside and pay all of those taxes yourself. And this is where a lot of people get caught off guard. Because when you get that first 5,000, 10,000, 20,000 of 10 99 income, it feels amazing. You're like, I just made 20 grand. This was the best decision ever to go out on my own. But then you've gotta pay your expenses. Tax season rolls around and you realize, whoops, I never set anything aside for taxes. And suddenly you owe thousands. That you weren't expecting, and that's kind of that welcome to being self-employed moment that no one really warns you about. Now the good news is that. That 10 99 income also gives you an opportunity because unlike W2 income where you basically have no say in how your taxes are handled, you can't deduct any expenses As a 10 99 earner, you have control. You can use strategy, you can deduct legitimate business expenses. You can decide how to structure your income to keep more of it, but only if you actually treat yourself like a business. So if you're listening right now and you're thinking, well, I just have a side gig, or I only make a little bit from freelance work, I want you to hear this. If you're receiving 10 99 income, you are a business owner, even if you haven't filed for an LLC yet, even if you're just doing it under your own name. When it comes to taxes, that's a business. so when you start treating yourself like one, that's when the magic happens. let's talk about what that actually looks like. So first you really have to separate your money. You need to have a dedicated business bank account, even if it's just a simple checking account at your local bank. Try to stop mixing your business income and personal spending in the same amount because not only does it make taxes a nightmare, but it also keeps you from truly seeing your numbers. And then you can start actually tracking. Your income and expenses, that's second. Okay? And you don't need fancy software or a bookkeeper right away. A spreadsheet works, but the goal is to know what's coming in most importantly, and then what's going out and what's left over. third, now that you have this information, you need to start setting aside money for taxes. A good rule of thumb is about 30% of your 10 99 income and 25% if. You are deducting your expenses accordingly, you could even just open a savings account labeled taxes and transfer money into it every time you get paid. And that way when quarterly estimates or tax season rolls around, you're not panicking. And one of the things that I wanna tell you here is that, I've just helped so many business owners over the year that, they get in trouble. when it comes time to file their taxes as a sole proprietor on Schedule C, they were unaware of self-employment taxes, ordinary income taxes. They don't have anything set aside, and then they're halfway through the next year where they don't have anything set aside. And that's one. Scenario that I see very often. And then the other scenario that I see is, I met with someone yesterday and she has the money set aside, but she's not actually paying in her estimates, like her quarterly tax estimate payments. And that's really gonna come back to hurt her because the, not only is she gonna get a failure to pay penalty, but she's also gonna get interest accrued because she wasn't paying them throughout the year. So that's really important to set the money aside and also pay it in. And then fourth, this is where the strategy comes in, right? Start looking at what deductions. Could qualify as business deductions because when you're a W2 employee, you're not thinking about deductions. Your employer is paying for everything, and even if there's something that you happen to pay for, you don't get to deduct it. But when you are attending a nine Earner, an independent contractor. The doors open wide for you, Think about everything you spend money on that helps you earn income, your laptop softwares, you're purchasing a home office, mileage if you drive somewhere, continuing education or trainings your phone part of your internet bill. Those are all, or can be legitimate business deductions depending on the type of business you have, and every deduction means you're paying taxes on a smaller amount of income, and that means that you're keeping more money. Now, where people get in trouble is when they don't plan ahead, right? Those scenarios I was talking about, they wait until tax time. Dump all their receipts on their CPA's desk and they're not tracking anything and then suddenly they expect magic. The tax strategy really minimizing your tax bill doesn't happen in April. It happens now before the year ends, while there's still time to implement strategies. So if you've been operating as a 10 99 earner, but you haven't been thinking like a business owner, I hope that this is your wake up call that you need to get proactive about your tax strategy before December. Because once the year closes, many of your best options disappear. now I wanna flip the script because many of you listening already see yourself as a business owner. And now you're maybe thinking, you're either already hiring, you're bringing people onto your team, adding virtual assistants, you either have them or you're on the edge of taking that plunge. And a question that we hear a lot is, should I hire them as a W2 or a 10 99? And it sounds like a simple decision, but it's actually really often misunderstood and it's a risky area for small business owners. So I wanna start with the basics because you, this isn't something that you just get to pick. A W2 employee is someone who works for you under your control. You tell them what to do, how to do it, when to do it. You provide the tools, the training, maybe even equipment. They're integrated into your business. They're part of your operations. You tell them what hours to work. A 10 99 contractor, on the other hand, is an independent business. They decide how they're going to do the work. They can take on other clients. They bring their own tools or systems. They're responsible for their own taxes. They make their own hours. The key difference is control and independence. Now I really get why so many business owners lean towards hiring contractors. On paper, it looks easier and cheaper. You don't have to run payroll, you don't have to pay employment taxes, your portion, you don't have to offer benefits. You can just cut them a check and send them a 10 99 at year end. But here's the reality check. If that person is working for you in a way that looks like an employee, but you're paying them as a contractor, the IRS has a big problem with that, and lately they've been cracking down hard. We're seeing more audits, more fines, more reclassifications, which is basically where the IRS says, no, that person was an employee, not a contractor. And then they hit you with back taxes, penalties, and interest. It is not fun and it can be really expense. So the IRS uses something called the common law test to determine classification. It looks at three main factors. The first is behavioral control. Do you control how the work is done? The second is financial control. Who controls how the person is paid, reimbursed, or profits from the business? And then three is the relationship type. So are there contracts? Are they receiving benefits? Is there permanency that looks like employee? so if most of these answers lead toward you having control, that's an employee. So here's an example that I thought of. let's say you hire a virtual assistant and you tell them, I need you online every day from nine to five. You'll use our systems, our templates, our email address, you review their work every day, and they don't have any other clients. That is not an independent contractor, that is an employee, but if you hire maybe a social media manager and they set their own hours, but they work for you when they want, you don't even know their hours to a certain extent. They use their own software, they have multiple clients. They deliver results based on agreed outcomes. That is more like a contractor. So I know that difference can seem subtle, but I hope that those two examples, you know, can show you the difference because It matters a lot. And listen, I get it. Hiring W2 employees feels heavier. It is more commitment, more paperwork, more responsibility. But sometimes that's the right move for your business, especially if the person is a core part of your operations and you want them committed to your business and long term. So here's what I often tell clients. If you're relying on someone every day, if they're doing work, that's critical to how your business runs. If you be in trouble, if they quit tomorrow, if you need them available, not at your beck and call, but they're available when you need them. That's an employee. On the other hand, if it's project based part-time or something super specialized, then a contractor is what it should be. I think the goal isn't to avoid employees. It's really to classify people correctly and know what the decision needs to be before you hire them so that you can account for the cost associated with whether they're an employee or a contractor, because misclassifying them as a contractor to quote unquote. Save money almost always costs you more later. Because the penalties can be steep, right? And you could even have the states get involved. And so before you bring someone on, think strategically about the relationship. Ask yourself, how much control do I want or need over their job? For example, my tax team, I wanna control how they serve our clients, how they do tax strategy. Think about are you their only client? Do you want them to grow with the company? A lot of these answers will guide you in the right direction. you know, something else I want you to think about is, as a business owner, you deserve to build a business that's sustainable. And having the right mix of employees and contractors can actually help you do that because employees. Generally create stability, but contractors create flexibility and you need both. And so my point here is that I want you to be intentional, not reactive, to think about what your business can handle right now, and even design a position that fits the IRS's test. If you're in growth mode, maybe you start with contractors. If you're in a season of scaling and needing consistency, it's probably time to bring on W2 earners. There's no one size fits all answer, but there is a right answer for your situation and for the position that you're creating. And that's exactly where tax strategy comes in, because when you're paying people correctly and when you're structuring your own income correctly, you can plan, project, and optimize so much more effectively. Remember what I said earlier about treating yourself like a business if you're earning 10 99 income? the same thing applies here. The more you act like a legit business owner, which is what you are, the more responsibility for how money flows in and out, and the more control you have over your outcomes. All right, let's tie that together because I know that this was a lot, whether you're the one earning the 10 99 or the one issuing it. The bottom line is this, understanding these two types of classifications for income is crucial. It impacts your taxes, your cashflow, and your long-term financial stability and wealth building. And right now, especially as we head into the end of the year. Is the time to pay attention. So if you've been getting 10 99 income and still thinking of yourself as just a freelancer or just a contractor, it's time for you to shift that mindset you're a business owner and start acting like one. That means thinking about strategy, not just survival. It means making moves before December 31st. That could save you thousands come April, and if you've been hiring help and you're not totally sure you've classified those people correctly, or you just have that nagging feeling that something might not be quite right, now's the time to clean it up before the year ends, before the IRS might come knocking. I want you to keep more of what you earn. That's the whole point of this podcast, right? It's not just about making money, it's about keeping it. And remember that happens through intentional strategy, smart decisions, and understanding how the system works so you can use the system to your advantage. So here's my challenge for you. Don't let another year end without getting clarity on your business's setup. Don't go into tax season next spring. Hoping it all works out. Take action now. If you've been listening to this and you're thinking, yep, that's me. I get 10 99 income, but I've never really looked at it as a business, or I'm hiring people and not sure if I've done it right, then I want you to DM me. Let's chat before the year ends. Let's talk about your situation and figure out. If this is something that you need to be thinking about and working on, because I don't want you overpaying, I don't want you under prepared or caught off guard when the IRS starts asking questions, because if there is one thing I want for you, it's to be confident in how you run your business and how you manage your money and how you make your business work for you. Because you've worked hard to earn it. You've worked hard to get to where you are, and I want you to keep as much as possible. And look, if the first thought that came up is, ugh, I should have been doing this months ago, that's okay. You're not behind. taking action now is what matters. Don't focus on the should haves or the lost time. Focus on now, you've still got two more months left in the year. Don't wait until your CPA tells you what you could have done or what should have happened. Let's make sure you're doing it now while it still counts. So send me a dm. I'm at. Kimberly Terrace, CPA, on Instagram, and I can't wait to chat with you. I can't wait to meet you and make sure that you are set up in a compliant way with the IRS and in a way that is going to help you keep more money. Thank you for being here, as always, it always just means so much to me and I can't wait to see you next week.