Tax Requirements for Independent Contractors

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 What Is an Independent Contractor? Why Hire an Independent Contractor?

An independent contractor is a person who works for a company, either while under a contract or on a job by job basis. Although independent contractors are employed to do work for a company, they are not considered to be employees of that company. In terms of work ownership, the independent contractor generally owns the rights to their own work.

An exception to this would be if the contractor and the employer have signed a written agreement which specifies that the employer is the owner of any and all works created by the contractor for that specific owner’s job.

What makes an independent contractor different from an employee is that they control what work they take on, as well as how they complete their work. Once again, this differs from an employee-employer relationship in which the employer controls when, where, and how the employee’s work is completed. Additionally, independent contractors do not have taxes withheld from their pay by their employer. Tax requirements for independent contractors will be further discussed below.

There are many reasons why an employer may choose hiring an independent contractor, as opposed to putting another employee on their payroll. One of the biggest reasons for doing so is that it can often save quite a bit of money. This is because you do not have to pay for the following costs associated with traditional employment:

Additionally, working with independent contractors may decrease your exposure to potential lawsuits. Although an independent contractor could potentially file a lawsuit against you for an injury sustained on the job, they cannot sue you for specific things related to traditional employment. An example of this would be job discrimination, or wrongful termination.

What Are the Tax Requirements For Hiring an Independent Contractor?

When hiring independent contractors, employers must be especially careful not to misclassify an actual employee as an independent contractor. This is because employers must pay social security, as well as federal and state taxes, on behalf of all employees. As such, an employer may be tempted to classify them as independent contractors, but this is illegal and can lead to serious consequences.

Before further discussing tax requirements for hiring an independent contractor, it is helpful to further discuss how to differentiate between an employee and an independent contractor. One of the main ways is to look at how the worker is being compensated for their work. If they are on the payroll, and are consistently receiving paychecks, they will most likely be classified as an employee.

Some of the other factors that would designate a worker as an independent contractor instead of an employee include:

  • The contractor provides all equipment necessary for completing the job;
  • At any time, the contractor may be dismissed without due process;
  • At any time, the contractor may choose whether or not to return to work without fear of losing their employment; and
  • The contractor controls their working hours.

Additionally, each state has its own rules determining whether a worker is an employee or an independent contractor. Generally speaking, if a person is considered to be an employee and not an independent contractor:

  • Their work hours are set by the employer, not the employee;
  • The employee cannot accept or reject projects at will; and
  • The company provides all necessary tools to complete the work required.

When hiring an independent contractor, employers are required to report to the Internal Revenue Service (“IRS”). They must report any payments made to independent contractors for services rendered to their business that amount to more than $600. This report is made by filling out a 1099-MISC form.

What Is My Liability As an Employer?

As previously mentioned, employers cannot legally misclassify a worker in order to avoid paying benefits. An employer may try to misclassify an employee as an independent contractor in order to avoid paying for expenses. Some of these expenses have been previously mentioned, such as:

  • Employee benefits;
  • Workers’ compensation insurance;
  • Overtime; and
  • Social security and medicare taxes.

Misclassifying an employee as an independent contractor instead of an employee will result in the employer being penalized. The United States Department of Labor, or “DOL,” and the Internal Revenue Service, both conduct regular audits into companies in order to discourage employers from engaging in such avoidance tactics.

In terms of penalties themselves, these will vary according to whether the misclassification was intentional or unintentional. If the IRS has reason to believe that the employer intentionally or fraudulently misclassified employees as independent contractors, considerably larger fines will be imposed on the employer. Additionally, criminal penalties may be levied, such as fines of up to $1,000 per misclassified worker and a prison sentence.

As an employer, if you intentionally misclassify an employee as an independent contractor, you will likely be held responsible for any unpaid taxes that you would have paid had you correctly classified that worker as an employee. The IRS may also penalize you, which can range anywhere from 12% to 35% on top of the taxes that you owe.

In addition to penalties imposed by the IRS, you may also be held liable for a number of different state agencies. An example of this would be if an employee that you had intentionally misclassified applied for unemployment. You may be held liable to the state unemployment agency that paid out those unemployment benefits.

What Should I Know As an Independent Contractor?

As non-employees, independent contractors are solely responsible for their actions, as well as their inactions. What this means is that, for many jobs, independent contractors must hold some sort of liability insurance. This would provide some sort of legal protection, should their actions or inactions result in any legal claims against them or the company who hired them for the job.

Furthermore, independent contractors are not permitted to enter into any contracts or agreements on behalf of the company who hired them. Essentially, they cannot act in any way that an employee of the company would.

The best way for an independent contractor to protect themselves from being sued is to carry some sort of liability insurance. Independent contractors should perform their obligations as specified according to the contract, and in the safest manner possible. Finally, independent contractors should never operate outside of their agreement with the company who hired them.

An example of this would be by contracting with third parties, or otherwise creating obligations for the company to fulfill. Another example would be taking on additional work for the employer, outside of what has been detailed within their contract.

Do I Need an Attorney For Issues Involving Tax Requirements For Independent Contractors?

If you are an employer considering hiring an independent contractor, you should consult with an experienced and local contract lawyer. Because state laws vary widely in terms of tax and employment law, working with a local attorney is the best way to ensure you receive relevant legal advice. An experienced business attorney can help you understand how to legally classify a worker, as well as what your liability is as an employer. An attorney can also help you adhere to all tax requirements.

If you are an independent contractor, a business lawyer can help you determine how best to protect yourself. An attorney can review a contract before you sign it. No matter if you are the employer or the contractor, an attorney will also be able to represent you in court as needed, should any issues arise.

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