It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors. Show
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. Select the Scenario that Applies to You:
Determining Whether the Individuals Providing Services are Employees or Independent ContractorsBefore you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be:
In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered. Common Law RulesFacts that provide evidence of the degree of control and independence fall into three categories:
Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. 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. Also, factors which are relevant in one situation may not be relevant in another. The keys are to look at the entire relationship and consider the extent of the right to direct and control the worker. Finally, document each of the factors used in coming up with the determination. Form SS-8If it is still unclear whether a worker is an employee or an independent contractor after reviewing the three categories of evidence, then Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax WithholdingPDF, can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status. Be aware that it can take at least six months to get a determination. A business that continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8PDF. Employment Tax ObligationsOnce a determination is made (whether by the business or by the IRS), the next step is filing the appropriate forms and paying the associated taxes. Employment Tax GuidelinesThere are specific employment tax guidelines that must be followed for certain industries.
Misclassification of EmployeesConsequences of Treating an Employee as an Independent ContractorIf 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). See Internal Revenue Code section 3509 for more information. Relief ProvisionsIf you have a reasonable basis for not treating a worker as an employee, then you may be relieved from having to pay employment taxes for that worker. To get this relief, you must file all required federal information returns on a basis consistent with your treatment of the worker. 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. Misclassified Workers Can File Social Security Tax FormWorkers who believe they have been improperly classified as independent contractors by an employer can use Form 8919, Uncollected Social Security and Medicare Tax on Wages, to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation. Voluntary Classification Settlement ProgramThe Voluntary Classification Settlement Program (VCSP) is an optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements.Apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, in order to enter into a closing agreement with the IRS. Why do companies hire contractors instead of employees?Simply put, money doesn't grow on trees and hiring full-time employees can be a costly endeavor if they're only needed for a known period of time. Between the hiring manager's time and the cost of full-time employee benefits, it simply doesn't make financial sense for many firms to hire permanent employees.
Why being an employee is better than independent contractor?An employee may be able to obtain better benefits than an independent contractor. Employer subsidized health, life, disability and retirement benefits represent part of the “hidden paycheck” for employees that independent contractors don't always enjoy.
What are the pros and cons of hiring employees vs independent contractors?Although employee salaries are typically lower than the hourly pay of an independent contractor, employees require additional business expenses. With employees, you may have to pay tax and their pension, and you may also need to offer other benefits such as medical coverage.
Is it better to be an independent contractor or W2 employee?1099 Independent Contractors
1099 contractors have a lot more freedom than their W2 peers, and thanks to a 2017 corporate tax bill, they are allowed significant additional tax deductions from what is called a 20% pass-through deduction.
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