Every person your company pays for labor or a service can be classified as either an employee or an independent contractor. Although it may not seem like a serious difference, making this distinction among employees is essential for tax purposes. If you fail to make the distinction properly, you may owe back taxes and fines to the Internal Revenue Service.

Tax Implications

When it comes to taxes, independent contractors are treated differently than employees. For employees, you must pay a certain amount of employment taxes to the IRS. This amount is based on the amount of wages the employee earns. You must also withhold a certain amount of the employee’s wages for federal and state income taxes. Independent contractors, on the other hand, are responsible for their own employment and income taxes.

How to Know the Difference

Fortunately, it’s not very difficult to determine whether to treat someone as an employee or an independent contractor. Individuals that qualify as employees typically work for only one employer. They perform duties dictated by the employer, and they may receive on-the-job training. Conversely, independent contractors usually operate a business under their own name, set their own hours and have more than one client at a time. They may also advertise their services, hire their own employees and send invoices for the work they complete.

Reporting Requirements

When a worker qualifies as an employee, you must withhold state and federal income taxes based on the information the employee provides to you on Form W-4. You must also report the employee’s annual earnings to the IRS using Form W-2, and you must send a copy of Form W-2 to the employee no later than January 31st of the following year.

You won’t have to withhold or pay any taxes on behalf of independent contractors. However, if you pay an independent contractor more than $600 in any given year, you must report this amount to the IRS using Form 1099. You must also send a copy of Form 1099 to the employee by January 31 of the following year.

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Canner Brody and Yan is a Miami CPA Accounting firm.  If you would like help with your taxes, simply call Andrew Brody at 305-231-2150.