Many companies are making changes to their workforce. Businesses are hiring more independent contractors and hiring fewer full-time employees. While your work as an independent contractor gives you a great deal of freedom, there are some tax and legal issues involved. To avoid problems, think through the process of becoming an independent contractor.
Hiring company’s role
If a company is considering hiring workers as independent contractors, they should refer to the IRS guidelines. Specifically, businesses need to determine if the worker is an employee or independent contractor.
The IRS guidelines are based on common law rules. Those rules address how much control the company has over the worker. For example, does the company have the right to control what the worker does, and how they do it? Does the business provide the tools and supplies used by the worker? Is the worker provided benefits, such as pension or insurance benefits?
Generally, if the answer to any of these questions is yes, the worker should be considered an employee.
Tax impact
Companies are obligated to withhold several types of taxes for employees. For example, firms must withhold federal and state income taxes from employee payroll. Those taxes are forwarded to the applicable taxing authority. Businesses also withhold and submit the employee’s share of payroll taxes for FICA and Medicare.
Payroll taxes have a component that is an expense for the employer. This additional cost can be significant for the firm. This is one reason why companies are shifting to independent contractor relationships. An independent contractor is responsible for all of their payroll taxes.
Issues for the independent contractor
If you work as an independent contractor, you are paid the entire gross amount you are owed. No withholdings come out of the payment. Entrepreneurshiplife.com points out that you’re responsible for paying both income tax and payroll tax on your earnings.
Independent contractors typically make quarterly estimated payments for federal and state withholdings. If, for example, your accountant estimates a 25% federal tax liability, you would withhold 25% of your payments for federal income taxes.
You are also responsible for your entire payroll tax. You pay both the employee and the employer’s portion. Many independent contractors use Schedule SE of the individual tax return to compute payroll taxes. One-half of your self-employment (payroll) tax is deductible on Schedule SE.
Choosing a business structure
It’s important to speak with an attorney or an accountant to choose a business structure for your independent contractor work. The business structure will help you properly report and pay both income tax and payroll tax. You may choose to work as a sole proprietor, as an LLC, or some other form of business.
Other costs to address
Independent contractors typically use their own supplies, tools and any other work-related equipment for their projects. In addition to a proper legal structure, you’ll need to pay for your own insurance.
Econtractorsinsurance.com explains some of the insurance policies that an independent contractor should consider. Many companies, for example, will require that you be bonded. Bonds ensure that the contractor will comply with local statures and laws, and protect the hiring firm against financial loss.
Working as an independent contractor offers a great deal of work flexibility. Before you start work, make sure that you have the legal and tax structure in place to succeed as a contractor.
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