Cannabis employers must meet numerous regulations across the organization, and making sure employees are properly classified doesn’t always rise to the top of the list. But employee classification is extremely important and affects how you pay your crew.
Employers often ask our cannabis-focused recruiting and consulting firm Higher Growth Search whether they should classify employees as W-2 workers or independent contractors. And the reason is this:
- If you have W-2 workers, you pay payroll and other taxes.
- If you have independent contractors, you don’t pay all of those taxes.
You can see the allure of classifying people as contractors.
Important to know: Despite any classification agreement you have with someone who provides work for you, the courts, IRS, and state agencies have the final say as to whether you can designate the individual as an independent contractor.
The penalties of misclassifying W-2 employees as independent contractors, interns, or volunteers can include time-consuming legal action, IRS fees, and substantial fines that might derail your entire enterprise.
This Justworks article helps illuminate the issue:
If the IRS suspects fraud or intentional misconduct, it can impose additional fines and penalties. For instance, the employer could be subjected to penalties that include 20% of all of the wages paid, plus 100% of the FICA taxes, both the employee’s and the employer’s share.
Criminal penalties of up to $1,000 per misclassified worker and one year in prison can be imposed as well. In addition, the person responsible for withholding taxes could also be held personally liable for any uncollected tax.
Who Is a W-2 Employee?
W-2 employees are essentially your “in-house” team. These individuals work directly for the company, are salaried and listed on payroll, and are entitled to benefits like vacation time, health insurance, and a retirement plan. W-2 employees are granted specific legal protections not usually extended to independent contractors. As a W-2 employer, it’s your responsibility to withhold Social Security and Medicare taxes, provide all necessary tools and equipment, and pay payroll taxes.
In short, a W-2 employee:
- Works for the company.
- Is upheld to the standards of the business.
- Is required by law to at least make minimum wage as their rate of pay, which may vary per state laws.
The employer of W-2 employees:
- Is responsible for withholding Social Security and Medicare taxes.
- Must pay employer payroll taxes.
- Must provide all necessary tools and supplies.
- Must reimburse employees for all business expenses incurred during employment.
Who Is an Independent Contractor?
As the name implies, independent contractors have, well, a good deal more independence. They bring specialized skills to the workplace without the company having to worry about payroll taxes, labor laws, or employment laws. They provide their own equipment and determine, through a contract agreement, how, when, and where they will provide their services.
Employers have very little oversight of independent contractors and may only hold them accountable to the services listed on the contract. For tax purposes, independent contractors fill out an IRS Form 1099 MISC instead of a W-2, making them personally responsible for paying the applicable taxes on their income, rather than their employer.
In short, an independent contractor:
- Fills out a 1099 for tax purposes, not a W-2.
- Takes on all tax liability (the employer/company is not responsible for withholding any payroll taxes).
- Works for themself but provides services to a company on a contractual basis.
- Signs an agreed-upon contract with the company (outlining the rate of pay, hours of work allotted to the client, defined length of the agreement, and the expectations of the services provided by the contractor).
- Must provide their own tools and supplies necessary to perform their services. There are no reimbursements for these business expenses by the company unless established in the contract.
- Is not eligible for employee benefits through a company and must take on all profit or loss risks without any liability to the employer.
Learn Your Local (and National) Labor Laws
Labor laws can vary state by state, but proper classification of employees and independent contractors is a universal concern for all cannabis businesses, no matter where they operate. We recommend studying the specific laws pertaining to your city, county, and state – and always erring on the side of caution.
A good rule to remember is that city regulations supersede county regulations, and county regulations supersede state regulations.
Staying current with cannabis regulations is essential, as local laws, ballot initiatives, and industry-wide rules change frequently. For example, ongoing discussion about employee classification will have a significant impact on California and the gig economy at large.
IRS Publication 15-A Employer’s Supplemental Tax Guide, Page 6, provides more details. As always, it’s suggested that you consult with a tax or legal expert for clarification on your specific situation.
Need help hiring full-time or senior-level candidates? Contact the direct hire and executive search experts at Higher Growth Search today. We’re here to help.