Dana the "Consultant" and the Deferred December Payroll
Bluebird Landscaping has four full-time employees and one "consultant", Dana, paid $4,500 a month. Dana works 8:30-4:30 at the shop, uses a company truck and phone, is described on the website as "operations coordinator", and has done the same job for two years. She invoices monthly, no tax is withheld, and no employer contributions are paid. In December the owner promised the crew lead a $6,000 bonus, payable 10 January. The final December payroll of $14,200, covering 24-31 December, is paid 4 January. Fourth-quarter payroll taxes of $5,900 ($2,300 employee withholding plus $3,600 employer share) are due 15 January. The owner asks whether to "just book the bonus and the taxes next year, since that is when the money leaves the bank".
1. Evaluate how Dana should be classified, applying the main factors, and outline the exposure if the current treatment is wrong.
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The label on the invoice does not decide it. The usual test looks at behavioural control, financial control and the relationship:
- Behavioural control: set hours and a set workplace indicate an employee; Dana has both.
- Financial control: the company supplies the truck and phone, so she has little investment of her own and no real ability to profit or lose from how the work is run.
- Relationship: two years of continuous, full-time service in a role that is core to the business, portrayed to the public as part of the team, is an employment relationship in substance.
On these facts Dana looks like an employee misclassified as a contractor.
Exposure if wrong: the company would owe the employer share of social taxes for prior periods, plus the employee share it failed to withhold (generally recoverable only with difficulty, often at the employer's cost), unemployment insurance, penalties and interest, and possibly retirement/benefits obligations. Two years of $54,000 annual payments means the retroactive liability is significant relative to a five-person business, and the 2024 accrual should not simply assume the current treatment continues.
Judgement point: do not quietly reclassify retroactively without advice - get a professional opinion, consider a voluntary disclosure route, and correct prospectively at minimum. If Dana is an employee, the $4,500 monthly payments should have run through payroll with withholding.
2. State which amounts must be accrued at 31 December and why, with the journal entries (ignore payroll tax on the bonus unless you can compute it).
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All three arise from December events even though the cash leaves in January:
1. Wages 24-31 December, $14,200. Earned in December; payment date is irrelevant. Dr Wages expense 14,200 / Cr Accrued wages (or Wages payable) 14,200.
2. Bonus, $6,000. The promise was made in December for work already performed, which creates a present obligation; the fact that a date was set for payment does not defer it. Dr Bonus expense 6,000 / Cr Accrued bonus 6,000.
3. Payroll taxes, $5,900. $2,300 is employee withholding - it is the employee's money held in trust, so it is a liability, not an expense, at the reporting date. $3,600 is the employer's expense for the quarter, including any portion relating to the accrued December wages. Dr Payroll tax expense 3,600; Dr Wages payable (or Withholding payable) 2,300 / Cr Payroll taxes payable 5,900.
If the $14,200 accrual is not yet subject to employer tax in the figures above, accrue the employer share on it as well (for example 7.65% = $1,086.30) so that expense and liability match the wages recognised.
3. Respond to the owner's "book it next year" proposal, focusing on the trust-fund element and internal control over payroll.
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Timing. The proposal fails the matching principle for the wages and the bonus, and it understates liabilities at the reporting date by at least $20,200 plus the employer tax element. December's profit would be overstated and January's understated - the reverse of what a reader would expect from a stable payroll.
Trust-fund taxes are not the company's money. The $2,300 withheld is collected from employees as agent. Late deposit or non-payment attracts penalties and interest, and in many jurisdictions the responsible individuals can be held personally liable for the withheld portion. Treating it as "just another January bill" is the wrong mental model: this liability should be paid on time even if other creditors wait.
Control issues exposed.
- One person apparently both runs payroll and decides when taxes are remitted; the owner only sees the bank balance.
- No accrual discipline means nobody reconciles the payroll register to the general ledger each month.
- No evidence of an independent review of the bonus decision - a verbal promise creates an obligation the bookkeeper cannot see.
Recommended cheap controls: a monthly payroll reconciliation prepared by the bookkeeper and reviewed and signed by the owner; a payroll tax calendar with the deposit dates and a named backup; bonuses documented in writing and approved before the period closes; and a standing year-end checklist that forces accrual questions to be asked.