Generally, you must withhold and deposit income taxes, social security taxes and Medicare taxes from the wages paid to an employee. Additionally, you must also pay the matching employer portion of social security and Medicare taxes as well as pay unemployment tax on wages paid to an employee. Generally, you do not have to withhold or pay any taxes on payments to independent contractors.
The important distinctions between these two worker classifications can seriously affect a worker’s wages and what taxes are paid by the worker or by the business. Get to know the difference between being an independent contractor and an employee to determine which is the right path for you. If you are an independent contractor and hired by a company or person to perform a service, chances are they will ask you to fill out a W-9 form. You must verify information, including name, address, and tax identification number.
Misclassified Workers Can File Social Security Tax Form
The pros of being an independent contractor generally relate to the greater freedom they enjoy. They can set their hours, pursue work they love, and decide what work they will and will not accept. Those who can work from home may save money on transportation and the wardrobe needed to work in an office.
Whichever path you choose, be sure that you know the tax implications involved in your decision. Additionally, the business aspects of the job are controlled by the company, such as paying the worker and providing supplies. Employees also receive benefits like pension plans, health insurance, and vacation pay. If the IRS or other government agency determines that a hiring firm has misclassified an employee as an IC, it can order the firm to treat the worker as an employee and require it to pay back taxes and substantial penalties. Being ordered to pay massive amounts of back taxes and penalties can easily put a small company out of business. Being reclassified is not necessarily great for the worker either–he or she could lose valuable business tax deductions.
Employee vs. independent contractor: Differences you need to know
When work is considered integral to the business, it is more likely that the person is an employee. On the other hand, work that is temporary and non integral may imply independent contractor status. However, whether these people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.
All of these items add enormously to the cost of hiring and keeping an employee. Typically, more than one-third of all employee payroll costs goes toward Social Security, unemployment insurance, health benefits, and vacation. Doctors, dentists, veterinarians, lawyers, and many other professionals who provide independent services are classified as independent contractors by the Internal Revenue Service (IRS). If an employer does not have authority over how a party accomplishes his or her work but simply give requests an outline, the relationship between the parties is that of hiring party/independent contractor. When the hiring party controls the way work is carried out and a product is delivered, the relationship between the parties is employer/employee. If you misclassify an employee as an independent contractor, you could have to pay substantial back taxes, fines, and penalties.
Independent Contractor (Self-Employed) or Employee?
They are responsible for all business costs—no reimbursable expense reports for them—and if working alone, they lack the support and camaraderie of coworkers. But to set yourself up for success, you’ll also need to think about your business name, finances, an operating agreement, and licenses and permits. While the independent contractor is his or her own boss, work stays within the definitions of oral or written contract and adheres to certain requirements. It looks at the dependence of the worker on the business for which he or she works. If a person gains a large portion of their salary from that business, chances are that person qualifies as an employee. I have extensive experience in all areas of media and entertainment including 11 years as an entertainment attorney, …
- When the hiring party controls the way work is carried out and a product is delivered, the relationship between the parties is employer/employee.
- The IRS and many states have adopted common law principles to define an independent contractor.
- Both the Department of Labor (DOL) and similar state-level organizations help to ensure that workers are properly classified by their employers, yet improper employee classification still leads to dozens of class action lawsuits per year.
- Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor.
- The cons of being an independent contractor are related to the risk of going bankrupt and the opportunity cost of a regular career.
- There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor and no one factor stands alone in making this determination.
- And you must pay half the Social Security and Medicare taxes due for the employee yourself.
Both the Department of Labor (DOL) and similar state-level organizations help to ensure that workers are properly classified by their employers, yet improper employee classification still leads to dozens of class action lawsuits per year. In determining whether the person providing service is an employee or an independent contractor, all information that independent contractor vs employee provides evidence of the degree of control and independence must be considered. In the United States, independent contractors are considered sole proprietors or single-member limited liability companies (LLCs). They must report all their income and expenses on Schedule C of Form 1040 or Schedule E if they have profits or losses from rental properties.
Consequences of Treating an Employee as an Independent Contractor
And you must pay half the Social Security and Medicare taxes due for the employee yourself. You’ll also have to pay for workers’ compensation and unemployment insurance coverage for the employee. Many freelancers in a gig-centric economy transition to https://www.bookstime.com/ independent contractors who work on a contractual basis to provide goods or services. Independent contractors may have a registered legal business name, earn any necessary certifications or licenses, and pay their estimated taxes quarterly to the IRS.
There are many advantages to being an independent contractor, like being able to establish your own schedule and knowing exactly what work you will be performing as outlined in your contract. However, there are also disadvantages, including a greater tax burden, less job security, and a lack of fringe benefits. While employees are allowed greater job security and are aided by their company in paying taxes, employees generally do not have the freedom to work their own hours, have less room for negotiation, and often over-extend their original job descriptions.
What Is the Difference Between an Independent Contractor and Self-Employed?
Common law principles further define independent contractor status by method of compensation. If a person is on an employer’s payroll and receives a steady paycheck, clearly that the person is an employee rather than an independent contractor. Since the introduction of virtual marketplace companies (VMC’s) like Uber, there has been some confusion about what is means to be an independent contractor vs. an employee.
You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977. See Publication 1976, Section 530 Employment Tax Relief RequirementsPDF, for more information. If you classify an employee as an independent contractor and you have no reasonable basis for doing so, then you may be held liable for employment taxes for that worker (the relief provisions, discussed below, will not apply). If you determine a worker is an employee, you must withhold income, Social Security, and Medicare taxes from the person’s pay.