As a business owner, you might need to hire a worker at some point or another. And depending on your type of business, you might need to hire employees, independent contractors, or both to get the job done.
But, how much do you really know about independent contractors vs. employees? Can you get away with hiring just independent contractors? Read on to learn what is an independent contractor and how they differ from employees.
What is an independent contractor?
Independent contractors are not like regular employees. An independent contractor is an individual who may run their own business but also performs work for other businesses. Individuals classified as independent contractors are not considered employees of your business.
Unlike employees, independent contractors do not have taxes deducted from their wages. You don’t need to withhold Medicare or Social Security taxes from independent contractors’ wages. Instead, contractors must pay self-employment tax on their earnings.
Here are a few examples of independent contractors in business:
- Construction workers
- Freelance writers
- Graphic designers
You might use an independent contractor to perform work or complete a specific project at your business. For example, you may hire a contractor to remodel your business’s storefront.
Contractors and Form W-9
When you hire an independent contractor, you must have the contractor fill out Form W-9, Request for Taxpayer Identification Number. Think of Form W-9 as a Form W-4 for contractors. On the form, contractors must provide information, such as their:
- Business name (if applicable)
- Business entity (e.g., sole proprietorship)
- ITIN, EIN, or Social Security number
IRS Form W-9 is used to report nonemployee compensation of $600 or more. At the end of the year, use Form W-9 to generate Form 1099-MISC, Miscellaneous Income, for your contractors.
Be sure to keep a copy of each contractor’s Form W-9 on file for your records. Do not send Form W-9 to the IRS.
Independent contractor classification
Misclassifying independent contractors is a big no-no in the business world. The IRS has strict definitions to determine whether or not a worker is an employee or independent worker.
Again, if the worker is an employee, you must withhold and remit certain taxes on their behalf (e.g., FICA tax, federal income tax, etc.). And as an employer, you are responsible for contributing an employer match on some taxes, such as Social Security and Medicare taxes.
If your worker is a contractor, you generally are not responsible for withholding or remitting any taxes on their behalf.
It’s critical for your business to accurately determine a worker’s classification. If you misclassify a worker, you could be subject to some hefty penalties and fines.
Both the IRS and the Fair Labor and Standards Act (FLSA) have classification regulations.
The IRS’s guidelines help you figure out whether your worker is an employee or independent contractor.
Typically, a business that has a contracted worker tells the contractor the scope of the job but doesn’t have control over how the contractor completes the project.
The IRS breaks down the degree of control and level of independence for contractors into three categories:
- Type of relationship
Before classifying a worker, consider how much control you have over a worker in the three above categories.
When looking at behavioral control, think about whether your company has the ability and right to control what the worker is doing and how they complete an assignment.
If you have control over the project, the worker might be an employee. If you can’t control the work, the worker is more likely a contractor.
For the financial category, ask yourself, Am I able to control other business aspects of the worker’s job? This could include things like how you pay the worker or how you handle expense reimbursements. For example, if you provide a worker with supplies, they are probably crossing employee territory. But if the worker brings their own supplies, they are more likely to be a contractor.
Lastly, you need to look at your type of relationship with the worker. Ask yourself questions like:
- Are there any written contracts in place?
- Do I provide the worker with any types of benefits (e.g., health insurance)?
- Will the relationship continue after the work is done?
Asking yourself these types of questions can help you determine if your worker is a contractor or an employee.
Some states set their own laws when it comes to classifying independent contractors. For example, California has a new California AB 5 law that requires most industries to use the ABC test to determine if a worker is a contractor.
Check with your state to see if there are any state-specific laws you must follow when you classify a worker.
In addition to the IRS’s regulations, employers must also look at regulations from the FLSA. The FLSA provides six factors to help employers determine a worker’s status. The factors include:
- 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 the business’s facilities and equipment
- If the work performed requires special skills and initiative
- The permanency of the work
- The nature and degree of control you have over the worker
Employers must look at all of the above points to determine worker classification, not just one. If you’re unsure about whether or not the FLSA’s factors apply to your worker, contact the Department of Labor for additional information.
Independent contractor tax liability
A worker’s employment status determines your payroll tax liability. As mentioned, if you classify a worker as an employee, you are required to withhold certain taxes, like Social Security or Medicare taxes. As an employer, you might also be responsible for remitting unemployment taxes, too (e.g., FUTA tax).
When you work with a 1099 independent contractor, do not withhold taxes. Instead, you will provide IRS Form 1099 to each applicable independent contractor so that they can report their income on their tax return. Give Form 1099-MISC to contractors you paid $600 or more during the year.
When you submit Forms 1099-MISC to the IRS, you must also send Form 1096. Form 1096 is the summary form of all 1099 forms you file.
You must give a copy of Form 1099-MISC to each applicable contractor by January 31. There are also several other copies you must submit to different agencies. Take a look at a breakdown of the different copies and their recipients below.
|Copy of Form 1099-MISC||Recipient|
|Copy A||IRS (along with Form 1096)|
|Copy B||Independent contractor|
|Copy C||Business (keep in your records)|
|Copy 1||State (if applicable)|
|Copy 2||Independent contractor|
Avoiding worker misclassification
If you’re having trouble determining a worker’s status, don’t worry. There are a few routes you can take to verify whether a worker is an independent contractor or employee. You can consult a small business lawyer or another professional or file Form SS-8.
Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, helps you determine the status of a worker.
You or your worker can file Form SS-8 by filling out and mailing the form to the IRS.
After you file Form SS-8, the IRS will send you and your worker either a determination letter or an information or courtesy letter that states the worker’s classification and the steps you need to take (if applicable).
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This article was updated from its original publication date of March 28, 2012.
This is not intended as legal advice; for more information, please click here.