by Michael Lodge
This subject is one that comes up almost every day. What is an employee and what is an independent contractor. So many professions are receiving form 1099-MISC at the end of the year for work they have performed for one single company or contract. So the question always comes up – what is a independent contractor and are they really an employee? So let’s go over the rules of employee or independent contractor – per the IRS. Now there are some states that are very aggressive on this issue, the State of California in recent years has come down heavy on truckers and their classifications. Many who thought they were independent contractors found out that they were really employees. So we have to be very careful on this subject if you own a business and ask the right questions in determining who is an employee or an independent contractor. You do not want the IRS or State hitting you up on an audit and making the determination of employee, it could be costly in back taxes.
Question: How do you determine if a worker is an employee or an independent contractor?
The determination can be complex and depends on the facts and circumstances of each case. The determination is based on whether the person for whom the services are performed has the right to control how the worker performs the services. It is not based merely on how the worker is paid, how often the worker is paid, or whether the work is part-time or full-time.
There are three basic categories of factors that are relevant to determining a worker’s classification:
- Behavioral control (whether there is a right to direct or control how the worker does the work),
- Financial control (whether there is a right to direct or control the business part of the work), and
- Relationship of the parties (how the business and worker perceive the relationship).
The key issue as an independent contractor is point of control. Who are you reporting to and who is directing your work? And do you manage anyone? Do you have an independent contract with the company you are working for? Do you have more than one contract? And the list goes on.
For more information on employer-employee relationships, refer to Publication 15, (Circular E), Employer’s Tax Guide, and Publication 15-A, Employer’s Supplemental Tax Guide. Also, refer to Publication 1779, Independent Contractor or Employee.
If you would like the IRS to determine whether services are performed as an employee or independent contractor, you may submit Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Generally, if you are an independent contractor you are considered self-employed and should report your income (non-employee compensation) on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship), or Schedule C-EZ (Form 1040), Net Profit From Business (Sole Proprietorship). Most self-employed individuals will need to pay self-employment tax (comprised of social security and Medicare taxes) if their income (net earnings from self-employment) is $400 or more. Use Schedule SE (Form 1040),Self-Employment Tax, to figure the tax due.
Generally, there is no tax withholding on income you receive as a self-employed individual as long as you provide your taxpayer identification number (TIN) to the payer. However, you may be subject to the requirement to make quarterly estimated tax payments. If you do not make timely estimated tax payments, the IRS may assess a penalty for an underpayment of estimated tax. For more information on estimated tax, refer to Publication 505, Tax Withholding and Estimated Tax. Unlike independent contractors, employees generally pay income tax and their share of social security and Medicare taxes through payroll deductions (withholding).
If you are an independent contractor make sure you have set up a quarterly payment schedule with the IRS. Remember you are really running a small business so you have to monitor your income and your expenses that offset the income. Many Independent contractors just feel this is their income like a W-2, but at the end of the year you are going to get a 1099-MISC with no taxes taken out – which means if you do not have any business expenses to offset the income – you will ow self employment taxes. You are running a business so act like it.
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