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Tuesday, July 6, 2010

Employees vs. Independent Contractors

W-2 vs. 1099-MISC

Small business owners have to understand the IRS definition of an employee and an independent contractor. The designation impacts employment taxes paid and who pays them. As the employer, you may be liable for taxes plus penalties if you misclassify an employee as an independent contract without reason.

An independent contractor is an individual or business who provides services to your business. Generally, when using an independent contractor, the employer has control over the result of the work, not the details required to get to that result. With an employee, the employer controls the when, how, and where as well as the what.

To determine the status of a worker, the worker’s relationship to the business is examined to assess the degree of control and degree of independence of the worker. Facts about the worker’s position fall into three categories defined by the IRS: behavioral control, financial control, and type of relationship.

Behavioral Control. An employee is subject to the business’ instructions about what work to perform, when and where to do the work, what tools or equipment to use. Materials and support services may be provided. An employee may receive training to perform his job. An independent contractor works with little or no direction, receives no training, and may set his own hours. He is responsible for delivering a product.

Financial Control. An employee is generally guaranteed a regular wage. An independent contractor is usually paid for a product, although some professions may charge by the hour. An independent contractor is free to seek other business opportunities, and can realize a profit or loss from his business.

Type of Relationship. If the worker is expected to work indefinitely and is not tied to a specific project, if the worker receives employee-type benefits, or if the worker performs activities key to your business, it is likely the worker is an employee.

The IRS assumes a worker is an employee, so you as the employer must have factual evidence to support the designation of an independent contractor.

W-2 vs. 1099-MISC
If a business has used an independent contractor during the year and paid him $600 or more during the calendar year, the business must provide the contractor with a 1099-MISC indicating the amount paid to the contractor during the year.

A business with employees must withhold federal and state income taxes, withhold social security and Medicare taxes, pay the employer share of social security and Medicare taxes, and pay unemployment taxes for each employee. By January 31st, the business must provide a W-2 for each person employed during the prior year.

IRS Circular 230 Disclosure


Pursuant to U.S. Treasury Department Regulations, we are now required to advise you that any federal tax advice contained in this communication, including attachments and enclosures, is not intended by the Sender or Sandra G Johnson, CPA, P.C. to constitute a covered opinion pursuant to regulation section 10.35 or to be used for the purpose of (i) avoiding tax-related penalties under Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.

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