It is very important that business owners know how to classify their workers, even if they have an accountant or payroll service to do the tedious work of calculating their compensation and making payments. Business owners may find it difficult and confusing to differentiate between employees and independent contractors; the tax structure is different for both the business and the worker.
For example, a business must withhold taxes such as, Medicare and social security from the wages it pays its employee’s. They are also responsible for employer’s quarterly payroll taxes. On the other hand, a business does not have to pay or withhold taxes on payments it is making to an independent contractor.
The Internal Revenue Service (IRS) uses three different criteria to determine the extent of independence of the worker, or the control which the business owner has on the worker. These criteria are:
The IRS has noted that the entire relationship and the extent to which the worker receives directions should be considered to determine whether he is a contractor or employee. After the business has decided whether the person is a contractor or employee, the business should document all the factors which resulted in the decision.
After a businesses has decided to hire a contractor, employee or both, they should be aware of the forms which has to be submitted for each type of worker according to the IRS. W-2 and 1099 are the most widely used tax forms
A business will have to submit a W-2 tax form for each employee at the end of the year. The form will specify the compensation paid to their employees annually and also indicate the payroll taxes which were withheld from the worker. The employer must mail the W-2 forms to their employees by January 31st of the next calendar year.
A business which hires an independent contractor should fill form 1099 instead and is legally responsible for sending the contractor a completed 1099-MISC form by the end of January 31st of the next calendar year if the contractor was compensated $600.00 or more.
The business or individual who will hire the contractor is also responsible for filing the 1099-MISC with the IRS. To do so, the business will also have to fill form 1096, which summarizes all the 1099 forms prepared. The form 1096 also has to be submitted to the IRS by January 31st. Businesses can order free paper copies of the 1099-MISC form from the IRS website.
Get Bookkeeping Out Of Your Plate, Let Our Professional Bookkeepers Handle It For You Today.