By Lee Allphin, Employer Advantage Founder and Chairman of the Board
Economic shifts have led to the rise of the gig economy, also known as the use of non-employees for temporary work. Gig workers go by several names including freelancers, consultants, and independent contractors and are different from traditional employees who have formal positions within their company. A growing number of companies are using these temporary workers, often for jobs that were historically performed by full-time employees, heightening the need for businesses to understand the regulatory requirements using these kinds of workers.
Paying taxes for traditional employees
One of the biggest differences in using employees or independent contractors is how employment taxes are paid and reported. When it comes to traditional employees, employers have essentially been tasked by the government to be tax collectors. Employers collect and deliver Medicare, Social Security and other taxes from every paycheck.
These traditional employees are sometimes called common-law employees or W-2 employees, named after the tax reporting form that employers give to their employees every year. The company withholds income tax, Social Security, and Medicare from wages paid to employees.
Paying taxes for independent contractors
Independent contractors are in a class of their own and are not considered employees. When it comes to contract work, the onus of tax collection, tracking, and reporting enters a new realm for both employers and their contractors.
For the independent contractor, the company does not withhold taxes. Instead, the company has the contractor complete Form W-9 to request the correct name and Taxpayer Identification Number. A Form 1099-MISC then needs to be submitted to the IRS by January 31 of each year for the previous year’s payment to the contractor. This form must be submitted for every contractor that you paid $600 or more in a year, according to the IRS. Employment taxes are then handled by the independent contractor.
Determining if an individual is a contractor
Companies must carefully determine whether each person they pay is an employee or an independent contractor because the regulatory requirements are so different for each class of worker. The degree of control the company has in the relationship with the person is key in determining his or her employment status. According to the IRS, the general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. Other questions to consider include:
- Does the company control or have the right to control what the worker does and how the worker does the job?
- Does the company control the business aspects of the worker’s job? These include arrangements like how the worker is paid, whether expenses are reimbursed, training to do the job, and who provides tools and supplies.
- Is there a written contract or employee benefits, such as a pension plan, insurance, or vacation pay?
- Will the relationship continue and is the work performed a key aspect of the business?
The Internal Revenue Service uses a right-to-control test to assess a business’ tax liability. Each state also has tests to determine a person’s status under workers’ compensation and unemployment insurance laws. The economic realities test used in most states makes it harder to classify a worker as an independent contractor because, in addition to the degree of control test, it considers the degree the worker is economically dependent upon the business. State-specific information is available from state workforce agencies.
A broader impact on your business
Paying taxes is only one example of the regulatory differences when dealing with employees compared to contractors. Other differences impact areas including hiring practices, reporting, pay rate, and pay date. If you have any questions seek qualified help in making this determination in order to avoid potential fines and regulatory intervention.
As the trusted Professional Employer Organization, Employer Advantage understands the rules and regulations whether you have employees, independent contractors or both. We can make fulfilling your worker administration and compliance obligations seamless.
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