Employee vs. Independent Contractor - Ten Tips for Business Owners

If you are a small business owner, whether you hire people as independent contractors or as employees will impact how much taxes you pay and the amount of taxes you withhold from their paychecks. Additionally, it will affect how much additional cost your business must bear, what documents and information they must provide to you, and what tax documents you must give to them.

Here are the top ten things every business owner should know about hiring people as independent contractors versus hiring them as employees.

Three characteristics are used by the IRS to determine the relationship between businesses and workers: Behavioral Control, Financial Control, and the Type of Relationship.

Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.

Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job.

The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.

If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.

If you can direct or control only the result of the work done -- and not the means and methods of accomplishing the result -- then your workers are probably independent contractors.

Employers who misclassify workers as independent contractors can end up with substantial tax bills. Additionally, they can face penalties for failing to pay employment taxes and for failing to file required tax forms.

Workers can avoid higher tax bills and lost benefits if they know their proper status.
Both employers and workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8 – Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding – with the IRS.

You can learn more about the critical determination of a worker’s status as an Independent Contractor or Employee at IRS.gov by selecting the Small Business link. Additional resources include IRS Publication 15-A, Employer's Supplemental Tax Guide, Publication 1779, Independent Contractor or Employee, and Publication 1976, Do You Qualify for Relief under Section 530? These publications and Form SS-8 are available on the IRS Web site or by calling the IRS at 800-829-3676 (800-TAX-FORM).

Contractor vs. Employee
Publication 1779
Publication 15-A

Independent Contractor vs. Employee

Are your workers independent contractors or employees? The answer can have a profound impact on how much tax you pay as a small business owner. Knowing whether your workers are or are not employees will affect the amount of taxes you must withhold from their pay. It will affect how much additional cost your business must bear, what documents and information they must provide to you, and what tax documents you must give to them.

Employers who misclassify workers as independent contractors can end up with substantial tax bills as well as penalties for failing to pay employment taxes and failing to file required tax forms.
Workers can avoid higher tax bills and lost benefits if they know their proper status.

Both employers and workers can ask the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS.

Generally, whether a worker is an employee or an independent contractor depends upon how much control you have as a business owner. If you have the right to control or direct not only what is to be done but also how it is to be done then your workers are most likely employees. If you can direct or control only the result of the work done, and not the means and methods of accomplishing the result, then your workers are probably independent contractors.

Three broad characteristics are used by the IRS to determine the relationship between businesses and workers - Behavioral Control, Financial Control, and the Type of Relationship. Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training, or other means. Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job. The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.

Knowing the proper worker classification can be critical to your business. Don’t guess. Act now to make certain you know for sure.

You can learn more about the critical determination of a worker’s status as an Independent Contractor or Employee at IRS.gov by selecting the Small Business link. Additional resources include IRS Publication 15-A, Employer's Supplemental Tax Guide, and Publication 1779, Independent Contractor or Employee. Both of these publications and Form SS-8 are available on the IRS Web site or by calling the IRS at 800-829-3676 (800-TAX-FORM).

Remember that for the genuine IRS Web site be sure to use .gov. Don't be confused by internet sites that end in .com, .net, .org or other designations instead of .gov. The address of the official IRS governmental Web site is http://www.irs.gov/.

Additional resources:

Contractor vs. Employee
Publication 1779
Publication 15-A

Paying Yourself Can Never Be Bad...

One of the biggest fears that millions of taxpayers face during tax season is having to file that dreaded 1099-Misc income on their returns. You work all year independently not having any federal, state, social security or medicare tax deducted, and now it’s time to pay those taxes.

Suddenly in January, you receive that 1099 in the mail and the sweat starts rolling. You furiously start digging for deductions. The IRS considers you to be a sole proprietor or independent contractor and you’ve got to file a Schedule C (Profit and Loss From Business) with your return. Your Tax Preparer enters your information and when you look at the finished return, you find that Line 58 of your 1040 under “Other Taxes” shows an amount for “Self-Employment Tax”. The first question that most of my clients ask is “What is this and why am I having to pay another tax?”. My first response is “Do you have a 401K or retirement plan?”. They suddenly look at me wondering why I’m asking that question and what does this tax have to do with my retirement. That’s when I begin my spill about “why paying yourself can’t be bad”.

When you’re a W-2 wage earner, your employer is responsible for taking out the necessary taxes, but when you work as a 1099 wage earner, you alone are responsible for the payment of these taxes. Federal tax payments can be made quarterly to the IRS, but self-employment taxes can only be paid at the end of the year when you file your return.

Self-employment tax is composed of a Social Security tax of 12.4% and a Medicare tax of 2.9%. For 2006, the maximum amount of wages and/or self-employment income subject to the Social Security part of the self-employment tax is $94,200. All net earnings are subject to the Medicare portion of this tax. Therefore, if your salary income as an employee is $94,200 or above, you would have already paid all the Social Security tax you owe. Your self-employment income would, however, be subject to the Medicare tax of 2.9%. There is no limit on the amount of earnings subject to the Medicare portion of the self-employment tax.

Simply put, they are social security and medicare payments that you make to yourself calculated on the “net” amount of your 1099 income. They are a mandatory tax imposed by the Social Security Administration, which are enforced and collected by the IRS. When collected, the IRS deposits these funds in your name with the Social Security Administration.

When you look at that final 1040 amount, and you realize that you are having to play catch-up on all the federal, state and self-employment taxes that were not paid during the year….yes, I can see where the sweating would begin. But please take some advice, even though you panic and sweat, don’t just go home and toss the return aside and not file. The result of not filing can result in a tax burden that far exceeds that of the original return balance. Failure to file can result in your having to hire a Tax Resolution service such as Effectur, Inc. to assist you in “making peace” with the IRS.

Remember self-employment tax is you paying yourself in the form of income and health care benefits at your retirement. So, “paying yourself can never be bad!”.

Sharon R. Raines, Financial Planner/Tax Preparer