Question

Payroll Accounting

What is the difference between an independent contractor and an employee? How does this status affect their taxes and reporting requirements on both employee and employer sides?

Answer 1

SOLUTION :

DIFFERENCE BETWEEN INDEPENDENT CONTRACTOR AND AN EMPLOYEE :

business may pay an independent contractor and an employee for the same or similar work, but there are important legal differences between the two. For the employee, the company withholds income tax, Social Security, and Medicare from wages paid. For the independent contractor, the company does not withhold taxes. Employment and labor laws also do not apply to independent contractors.

To determine whether a person is an employee or an independent contractor, the company weighs factors to identify the degree of control it has in the relationship with the person.

• 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, 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 a key aspect of the business?

The table highlights some differences in the business relationship with employees and independent contractors.

DESCRIPTION	EMPLOYEE	CONTRACTOR
Employment Laws	Covered by a number of federal and state employment and labor laws	Not covered by employment and labor laws
Hiring Practice	A potential employee completes an application that is handled by Human Resources. The approved applicant receives a job offer. After a person accepts the position, the employer must ask for additional information about the employee such as date of birth, marital status, and citizenship status.	A potential contractor normally interacts with the person or department that wants a certain service or task completed. A potential contractor might complete a proposal. The contractor enters into a contract, including a Statement of Work with the legal or procurement section of the business.
Tax Documents	Provides name, address, Social Security number, tax filing status, and number of exemptions on a W-4	Provides name, address, Taxpayer Identification Number, and certification about back up withholding
s Tax Reporting Requirements	Reports all money paid to the employee during the tax year on a W-2	Reports payments of $600 or more in a calendar year on a Form 1099
Reporting to Other Agencies	Reports for state and federal Unemployment Insurance	None
Value of Work or Contract	Earns either an hourly rate or a salary	A contract may be for a total amount. It could be for an hourly, daily, or weekly amount that ends on a specific date or a total amount to be paid when the job is completed.
When Paid	An employee pay period must remain the same unless formally changed. Pay periods vary from one week to one month. Federal and state laws require that an employee be paid on the normal pay date or earlier if the pay check is not negotiable on the normal pay date, which can occur on holidays.	Accounts Payable pays a contractor after receiving an invoice. The terms of the contract or Statement of Work dictate when payments are made, such as upon completion of a task or by periodic amounts. Contractors are not paid by payroll staff in most businesses.

HOW IT AFFECTS THEIR TAXES AND REPORTING REQUIREMENTS

Taxation :

When you’re an employee, your boss pays half of your Social Security and Medicare taxes (together, usually referred to as FICA taxes) and withholds your half of these taxes from your pay. That, along with withholding of income tax (both federal and state)

But as an independent contractor, you pay 100% of the FICA taxes when you file your tax return. You also must pay the income taxes that weren’t withheld.

. Taxes

When it comes to taxes, as a client you will complete the form W-9 to request the correct name and Taxpayer Identification Number (TIN) of the independent contractor, and Form 1099-MISC, to report payments made. As a client, you don’t have to worry about withholding taxes for contractors you engage. Independents should be aware of their own tax responsibilities. They pay what’s known as self-employment (SE) tax, which includes both the employer and employee halves of Social Security and Medicare (FICA).

Basically all incomes are taxable :

You might think that being an independent contractor will help you escape taxes.

That’s possible, but it’s not legal.

It doesn’t matter whether your payment is cash, check, digital transfer of funds or barter. It’s taxable income, regardless of the payment method or amount.

Additional confusion over taxable contract income also comes from the amounts the IRS uses to trigger reporting of the earnings.

When you’re a contractor, instead of a W-2 you get a separate Form 1099-MISC detailing what you made for each individual job. The IRS gets copies, too.

But an employer does not have to send you, the independent contractor, a 1099 if you made less than $600 during the tax year.

That, however, is just a reporting requirement. It has no effect on your taxable income. Any amount you earn is legally taxable and you should report it, either on Schedule C or as other income on Form 1040. So these were the affects of such differences between the independent contractor and the employee .

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