An independent contractor is an individual who may run their own business, but performs work for other businesses. Independent contractors are not considered employees.
Independent contractors do not have Medicare tax or Social Security tax deducted from their paychecks. They pay their own self-employment taxes and income tax on earnings. Employees, on the other hand, are individuals hired by a business to perform certain work at the direction of the employers.
IRS criteria for independent contractors
The Internal Revenue Service (IRS) has strict definitions to determine if a person working for a business is an employee or an independent contractor. If the worker is an employee, the employer must withhold, match, and remit certain taxes. If the worker is an independent contractor, employers are generally not liable for withholding taxes.
It is important for a business to accurately determine if the worker is an employee or independent contractor. There are unique tax considerations with each business relationship.
The Fair Labor Standards Act (FLSA) lays out six economic realities (factors) to use to determine the employee status of your worker. These are the six factors:
- If the work done is an integral part of your business
- If the worker’s managerial skills affect their opportunity for profit and loss
- The worker’s investments in facilities and equipment for the business
- The worker’s skill and initiative
- The permanency of the work
- The nature and degree of control you have over the worker
Employers can file Form SS-8 to help you classify workers as employees or independent contractors. This form asks a series of insightful questions about your relationship with the worker. Send the completed form to the IRS. The IRS will return a determination letter with their findings.
Tax liability for employers
A worker’s employment status determines your payroll tax liability. For an employee, you are required to pay federal and state unemployment tax, disability premiums, Workers’ Compensation, and the employer’s contribution of Social Security tax and Medicare tax, as well as remit employee contributions.
You do not pay these taxes for independent contractors. When you agree to work with an independent contractor, IRS Form W-9 needs to be completed. Use information on this form to generate another form, 1099-MISC.
You use Form 1099-MISC to report payments you made to the independent contractor. It is the independent contractor’s responsibility to report income on their tax return. Give the independent contractor Form 1099-MISC if you paid them $600 or more in one year.
Employers who do not classify workers properly may be subject to a worker classification audit, and may be liable for past taxes and penalties. To make legally correct classifications of workers, refer to the IRS guide Independent Contractor (Self-Employed) or Employee?.
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