How to Organize Your Payroll to Deal With Employees and Independent Contractors

by J.B. Maverick

2 min read

To keep your business running smoothly, you may need a mix of employees and contractors. Workers in both of these categories can do essential tasks to support your company, but from an accounting perspective, you need to treat these individuals very differently.

Classifying Contractors and Employees

Generally, contractors have control over when and how they complete a job for you. Employees, in contrast, usually have to yield to schedules and methods that you determine. Additionally, contractors are essentially small business owners. They bring their own tools to the job, and they manage their own profit or loss risk. It’s critical from a financial and legal standpoint to classify workers correctly. For example, in most cases, if an independent contractor gets hurt on the job, you are not liable for their injuries. In contrast, you pay Employment Insurance premiums on behalf of employees so that they are covered in the event of injuries. If WorkSafe, the Workplace Safety and Insurance Board, or the relevant organization in your area determines that you misclassified an injured contractor, you may be held responsible for retroactive EI premiums. Additionally, the safety board in your province or territory may assess interest and fines on the penalty. In addition to direct costs, misclassifying workers can also hurt your reputation as an employer.

Tax Considerations

When you hire employees, you have to withhold payroll taxes, Canada Pension Plan payments, and EI premiums from their cheques. You also must make CPP payments and EI premiums to the Canada Revenue Agency in addition to the amounts your employees pay. You don’t have to worry about independent contractors’ taxes. You simply cut them cheques for the work, and they take care of their own tax obligations.

Setting Up Payments

To set up payments for employees, you may want to use payroll software. This type of software helps you calculate the payroll taxes and deductions for your employees. If you develop your own in-house payroll software, the CRA publishes a list of the formulas to use annually. In most cases, you should not pay contractors with payroll software. Instead, you should create a record of how much you owe the contractor in the accounts payable section of your accounting software. In some cases, the contractor may even send you an invoice to make this easier.

Filling Out Tax Forms

New employees should fill out Form TD1. This worksheet calculates their personal tax credits, so you know how much taxes to withhold from their cheques. At the end of the year, you must give employees T4 slips. Finally, if you require your employees to provide their own supplies or use a home office, you also need to fill out Form T2200, Declaration of Conditions of Employment. With independent contractors, the paperwork is much lighter. At the end of the year, you simply have to give contractors Form T4A-NR, which details how much you paid them. You may also want to sign a contract at the beginning of the relationship to outline the expectations and payment arrangements.

References & Resources

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