When a person is paid on the form W-2, the employer automatically withholds and pays all of the necessary employee income taxes as required by the IRS. These taxes include: Federal Income Tax, State Income Tax, and FICA (Social Security and Medicare). In addition, the employer will pay all of the necessary employer taxes. These taxes include: FICA (Social Security and Medicare), FUTA (Federal Unemployment Tax), and SUI (State Unemployment Tax).
When a person is paid on the form, 1099-misc, all money earned by the individual is paid on an untaxed basis. It is then the responsibility of the individual to file and pay the appropriate taxes.
Could the contractor be considered an independent?
An individual that is an independent contractor fills the following roles:
- The independent contractor will work with a number of clients.
- The independent contractor’s role is to accomplish a final result and it’s the independent contractor who will determine the best way to achieve that result. The independent contractor will define what the agreed upon “result” is in a contract with your customer.
- The independent contractor pays his/her own taxes and files the required government forms.
- A city license, business license, and a fictitious name or dba statement will be obtained by the independent contractor. Also, the independent contractor must obtain any necessary permits.
- Social Security taxes are the sole responsibility of the independent contractor.
- The independent contractor must obtain his/her own benefits including workers’ compensation, disability, etc. The independent contractor is not entitled to any typical employee benefits from any government agency.
- The independent contractor can deduct business expenses from his/her income tax.
Does Incorporation Matter?
There is a lot of confusion regarding independent contractors. Many employers realize that it is not a good idea to pay contractors on a 1099, but believe that if the worker is incorporated, it is okay. This is not necessarily the case. It is very simple to obtain a Federal Tax ID number for a business. This ID number is not an automatic protection from misclassification.
As always the IRS’ 20 Point Checklist comes into play. Ultimately, the IRS is going to look at the work environment and who has control. An individual that is incorporated and working at a company could easily be considered an employee depending on the circumstances.
Three Main IRS Factors
Basically, the IRS’ 20-Point Checklist focuses on three main factors:
- How much control the employer has over the worker’s behavior and work results. (Who controls training, where and what time the person works, what equipment they use?)
- How much control the employer has over finances? (Does the employer have primary control over the person’s profit or loss?)
- What is the relationship between the parties? (Does the worker receive benefits? Is it a long-term relationship?)
IRS Questions in Court
Ask the five questions one court asked an employer (company) when considering whether workers were common-law employees:
- Who recruited them? (Recruiter/company = more risk.)
- Who trained them? (Company training = more risk.)
- What was the duration of employment? (Longer assignment = more risk.)
- Did you have the right to assign extra work? (Yes = more risk.)
- Did you have control over such things as firing, discipline, and rewards? (Yes = more risk.)