Many business owners choose to contract outside help from time to time. Sometimes, specific expertise is needed when there is a problem at your company. Instead of hiring more employees to help with basic business operations, you might hire an independent contractor.
When you hire an independent contractor instead of an employee, the rules are different. Independent contractors are required to fill out Form W-9 instead of Form W-4 when they are hired.
What’s the difference between an independent contractor and employee?
Determining a worker’s status is difficult. But, you need to correctly classify your worker to avoid IRS penalties. Use the economic realities test to help you decide. The economic realities test looks at six factors that can help define an independent contractor vs. employee.
When employees begin working at your business, they fill out IRS Form W-4, Employee’s Withholding Allowance Certificate. This form lets you know how much to withhold for federal income tax.
An independent contractor is a self-employed individual or someone who works for a different business. They are hired to accomplish a task, but they are not included on your payroll. You do not withhold any taxes from their pay because they must pay self-employment tax.
When independent contractors begin performing work for your business, they must fill out Form W-9. This form gives you information that will help you stay compliant with the IRS.
What is Form W-9?
Once you’ve determined that a worker is an independent contractor, you must give them Form W-9, Request for Taxpayer Identification Number. All businesses are required to report nonemployee compensation of $600 or more on Form 1099-MISC. Use the information on Form W-9 (i.e., tax identification number and contact information) to accurately fill out Form 1099-MISC.
Think of Form W-9 like a Form W-4 for independent contractors. They need to fill it out when they are hired at your business. And, the form has secure information on it that must be protected.
It’s important to understand Form W-9 instructions. Here are the Form W-9 requirements that independent contractors must provide:
- Business name if different than name
- Business entity (sole proprietor, LLC, C corporation, S corporation, partnership)
- Taxpayer Identification Number (Social Security number or Employer Identification Number)
- Certification: signature and date
You do not send Form W-9 to the IRS. Keep Form W-9 for your records.
Form W-9 purpose in a nutshell: To get information from your independent contractors, including their Taxpayer Identification Number, so you can accurately report their payments to the IRS.
What is backup withholding?
Most of the time, independent contractor pay is not subject to backup withholding. But, it could happen.
Backup withholding requires you to withhold 24% of the independent contractor’s payments and deposit with the IRS. It’s basically a tax that you withhold from the independent contractor’s wages and remit to the IRS.
For example, you owe an independent contractor $3,000. After backup withholding, you pay them $2,280 and send $720 to the IRS ($3,000 X 0.24).
Backup withholding applies if:
- The independent contractor did not include their TIN on Form W-9
- The independent contractor did not certify their TIN
- The IRS tells you that the independent contractor’s TIN is wrong
- The IRS tells the independent contractor their payments are subject to backup withholding because they didn’t report interest and dividends on their tax return
- The independent contractor did not mark that they were exempt to backup withholding
Make sure the independent contractor knows you are withholding taxes from their pay. And, include the backup withholding information in a document, like a pay stub.
An independent contractor’s pay is not subject to backup withholding if they give you their correct TIN number and the right certifications and report their taxable interest and dividends on their tax return.
If an independent contractor’s payments are subject to backup withholding, you need to deposit the money with the IRS and report it. Use Form 945, Annual Return of Withheld Federal Income Tax.
On Form 945, you must report the amount of backup withholding you collected. Form 945 is only due once at the beginning of each year (January 31 with some exceptions), but deposits are more frequent.
You will deposit the money either semiweekly or monthly, similarly to federal income tax withholding for employees. Your depositing schedule is determined by your total tax liability reported on Form 941 during a four-quarter lookback period.
What is Form W-9 used for?
Form W-9 tells you the independent contractor’s information so that you can correctly fill out Form 1099-MISC, Miscellaneous Income.
You are required to report nonemployee compensation on Form 1099-MISC, then send a copy to:
- The independent contractor
- The IRS
- The state tax department (if applicable)
- Your records
Independent contractors use Form 1099-MISC to fill out their individual income tax return, Form 1040. Be sure to send Form 1099-MISC by January 31.
How do I get a W-9?
As the business owner, you are required to get Form W-9s for your independent contractors. You can download a printable W-9 form straight from the IRS’s website.
Once an independent contractor completes Form W-9, keep it in your records. You need it to file Form 1099-MISC. Patriot’s online 1099 Software lets you create and print unlimited 1099s. And, we offer free, U.S.-based support. Try it for free today!