Employee or Contractor

Last Updated: Jan 08, 2015 07:16PM PST

As a business owner, you may have people working for you in your company, and it is important to correctly classify them as either independent contractors or employees. In the United States, the Internal Revenue Service (IRS) is very strict at tax time with business filings. However, it is also important for the person working for you to know his or her status. When a person is an employee, whether part-time or full-time, there are income taxes withheld, and the company is responsible for the payment of FICA (Federal Insurance Contributions Act) taxes for Social Security and Medicare, as well. If the person is an independent contractor, the business or company does not withhold or pay any taxes, and different forms must be used for the IRS.

If you have employees, they are required to fill out “W-4″ forms from the IRS that you use to figure how much income and FICA taxes to withhold from their paycheck. Either you or your accountant can use the tables supplied at the IRS website to correctly figure the amount of withholding, or you can use a payroll processing software application or company, depending on your needs and the size of your business. Either monthly or semi-weekly, you are responsible for submitting to the IRS the amount of taxes withheld from your employees. By January 31st of the following year, you must remit to your employees a complete withholding statement so that they can submit their previous year’s tax return.

If you have independent contractors, there is no withholding from their paychecks, and you do not have to submit any paperwork quarterly for tax purposes; although you can request that a “W-9″ form is completed for your records. However, you will still want to keep very close track of the compensation paid to your contractors. With a comprehensive small business accounting software package, you can keep track of the invoices submitted by your contractors and the payments made to them either electronically or with paper checks. Your online accounting software will help to ensure that the payments are debited to the correct line item. At the end of each calendar year, again by January 31st, you must remit to each contractor who was paid $600 or more in the previous year a “1099″ statement of their compensation so that they can submit their previous year’s tax return.

Because taxes are not automatically withheld from the paychecks of independent contractors, they must be sure to pay their own taxes quarterly; or they may end up with late fees and penalties for under-payment of taxes at the end of the year. Although it is not required, sending your contractors quarterly statements will help them to pay their own taxes on time.

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