As the remote work environment continues to remain popular among many employers, so does the ability to use independent contractors to supplement the workforce. While the use of independent contractors may help businesses control workforce costs and respond to demands if workloads increase, it is important that employers meet their payroll tax obligations and understand the tax implications and risks of using independent contractor.
Differences Between Independent Contractors and Employees
An independent contractor is an individual or business that performs services for another person or entity with a contracted understanding between the parties. Independent contractors are not employees of the business or entity they are providing services for as they are distinct from employees who work regularly for a single employer.
One of the benefits of using independent contractors is that generally, employers are not responsible for payroll tax obligations. However, while employers may not be responsible for independent contractor taxes, they have to be careful not to misclassify employees as independent contractors. The distinction between the two is not always clear and depends on the unique circumstances in each case.
Both the Department of Labor (DOL) and the Internal Revenue Service (IRS) maintain important definitions and rules for independent contractor status and misclassification of independent contractors can expose employers to significant penalties and fines. To help avoid this, the IRS has developed a https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee, drawn from the common law. Factors used to evaluate the right to control and the validity of independent contractor classifications are:
- Level of instruction;
- Amount of training;
- Degree of business integration;
- The extent of personal services;
- Control of assistants;
- Continuity of relationship;
- The flexibility of schedule;
- Demands for full-time work;
- Need for onsite services;
- A sequence of work;
- Requirement for reports;
- Method of payment;
- Payment of business or travel expenses;
- Provision of tools and materials;
- Investment in facilities;
- Realization of profit or loss;
- Work for multiple companies;
- Availability to the public;
- Control over the discharge; and
- Right of termination.
Use this comprehensive payroll taxes guide to adhere to the necessary guidelines, maintain effective tax compliance and prevent potential mistakes.
Who Pays Independent Contractor Taxes?
When independent contractors are paid, employers are not required to whithold taxes from the wages. However, independent contractors will generally pay taxes similar to a self-employed individual. For example, they generally pay self-employment tax, similar to the FICA taxes.
With FICA taxes, half of the taxes are withheld from the employee’s paycheck and the other half is paid by the employer. With self-employment tax, independent contractors pay the entire tax if their net earnings for the year were $400 or more. Independent contractor taxes also include federal, state, and local income taxes.
When employers determine that someone performing services for them is an independent contractor, they need the following forms for independent contractor taxes:
Form W-9, Request for Taxpayer Identification Number and Certification
Form W-9 is used to request an independent contractor’s taxpayer identification number (TIN). This ensures that payments are made to the appropriate individual or the independent contractor’s business and that the IRS receives the correct information. The TIN reported on the Form W-9 can be the contractor’s Social Security number or an employer identification number.
Form W-9 should be completed by contractors at the start of their working relationship with a company. There is no IRS filing deadline. Instead, the business paying the independent contractor should maintain the form and use the data supplied to ensure that proper compensation is issued.
This form for independent contractor taxes should be retained on file for four years in case any questions arise from either the contractor or the IRS.
Form 1099-NEC, Nonemployee Compensation
Depending on how much employers pay independent contractors each year, they may have to report those payments using Form 1099-NEC. This form for independent contractor taxes is filed with the IRS and also provided to the contractor for reporting income. Previously, the 1099-MISC form was used for independent contractor payments, but now it is used to pay payments classified as other income.
Businesses using the services of independent contractors complete this form only for those contractors who were compensated $600 or more during the tax year. Form 1099-NEC should be completed at the end of the year and sent to independent contractors at their correct addresses.
When it comes to state requirements for independent contractor taxes, employers should be aware that individual states may also require information from businesses regarding payment to independent contractors.
Compliance with Requirements for Independent Contractor Taxes
As the employment landscape changes and arrangements with freelancers become more common, employers should learn to take advantage of the skills, flexibility and cost benefits that independent contractors can provide. However, hiring them is not without risk and it is critical for employers to ensure proper worker classification and meet the requirements for independent contractor taxes.
Therefore, establishing a comprehensive compliance program is critical to avoid financial losses and to benefit fully from the opportunities independent contracting can offer. To simplify this process, employers can outsource payroll tax management and confidently resolve any questions regarding the nuances of worker classification while meeting the regulations governing independent contractor taxes.