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Employee vs. Sub-Contractor

As an employer, you have certain responsibilities for withholding taxes associated with paying your employees, including federal income taxes and FICA, which is for Medicare and Social Security. These taxes are not going to be withheld if you use independent contractors. This can get rather confusing, as it may be difficult to determine if you are actually using an independent contractor or an employee.

Sometimes small business owners decide they are using subcontractors because they are cheaper, they assume less liability, and the party has agreed to be paid as a sub-contractor.  What is important to understand is whether, in the event of an audit, the IRS would consider them an employee based on their criteria.

A number of things need to be considered in order to see if you're using an independent contractor or an employee as seen by the IRS. These would include the following factors, which would need to be considered in every case.

Behavioral Control - This is in regards to how much control you have over the work that is done. It is directly associated to your right to direct or control how much work is done, when the work is done and how the work is done.

Financial Control - Similar to behavioral control, this is in association with the rights that you have to control the individual who is doing work for you. An independent contractor will likely have his own tools or equipment, as well as being able to claim profits and losses and have significant out-of-pocket expenses.

Relationship of the Parties - Do you provide benefits to the individual who is working for you, such as pension and insurance? This may be used to determine that they are an employee. It is also important to consider the importance of the services that are provided for you.

It is important to understand that signing a contract does not necessarily mean that you are using an independent contractor. It is also possible to sign a contract with an employee. The importance of classifying those who are working for you properly can also be seen in the fact that a misclassification can make you responsible for all of the employer back payroll taxes, plus penalties, interest and possibly a fine.

If you have any questions as to whether you are using an employee or an independent contractor, you can contact Tax Force Inc. You may also be able to get further information by filing form SS-8 which can be used to determine the status of the worker. Tax Force Inc can assist you in filing that form.

Responsibilities If You Have Employees

Once it has been determined that you have employees, you have a number of responsibilities that need to be considered, including the following.

Legal Eligibility to Work - It is your responsibility to determine that your employee is a US citizen, legalized national or permanent resident of the United States that has permission to work in the country. Every employee must complete Form I-9.

Form W-4 - This is the Employees Withholding Allowance Certificate. It is used to calculate withholding taxes and includes information about marital status, deductions, exemptions and any extra money that is to be withheld.

Keep originals of Form I-9 and Form W-4, as well as all required documents on file.

Verify Social Security Number - It is necessary to verify the Social Security number of any employee. You can do this for up to 10 employees instantly or up to 250,000 on the next day through the Social Security number verification service provided by the IRS.

State Hire Registry - When you have a new employee, you need to send information to the state hire registry. The information will be matched to see if they owe child support. It is typically enough to send a copy of the W-4.

Form W-2 - This form shows the amount of tax that is withheld from an employee and their total compensation. This form is used by the Social Security Administration to update lifelong earnings so that Social Security can be calculated. You may be penalized if you have a mismatch on the W-2 of the employee's name and their Social Security number.

Earned Income Tax Credit - EITC is a refundable tax credit provided for those who work but do not earn a high level income. It may be your responsibility to notify employees that they might be able to take advantage of this tax credit. It may result in a refund for those individuals.

Individual Taxpayer Identification Numbers - These numbers are issued to those that do not have a Social Security number and are not eligible for a Social Security number. It is not valid for use on the W-2.

Independent Contractors

You will need to provide a Form 1099-MISC to any independent contractors paid over $600, which you used during the year as well as the copy to the IRS. There are filing requirements for Forms 1099-MISC. You also need to file it with the state, but you may be able to file electronically using the FIRE system, in which case you may not be responsible for filing directly with state. You should check with your state for details.

Have all sub-contractors fill out a Form W-9 form before they provide any services.  This will assure that you have the necessary information for the issuing of the 1099-MISC and you won’t have to track them down next January.  Also, we are not attorneys, but we always recommend having a sub-contract agreement signed as well.  If you need a referral to a trusted business attorney, please call and we would be happy to introduce you to one.

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