When you think of a contractor you probably think of someone you hire to do work. If you want to build a house you find a contractor and sign a “contract” with them to do the construction. You don’t think about them as an employee. For the IRS the difference between someone being a contractor and an employee is very important. It affects how much tax, and what kind of taxes they pay.
From the IRS website:
“People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether these people are independent contractors or employees depends on the facts in each case.”
The IRS has a set of conditions that must be met for someone to be paid as an independent contractor. Some of the things that employers must consider are:
These and other factors must be considered, but it is the company’s responsibility to follow those rules. As the employee you should already know if you are being paid as an employee or an independent contractor. Not knowing how you will be paid can cause a real tax headache.
When you are the person getting paid to work, being an independent contractor or an employee, might not seem important. You just want to be paid for your work. The truth is you aren’t likely to notice much of a difference, until it’s time to do your taxes. In most cases, when you get paid as a contractor your take home pay you will be higher. More take home pay on each check or direct deposit makes being a contractor seem like a great way to get paid. Until you consider the reason you are taking more of your pay home.
For you, the difference between being paid as an employee or a contractor really comes down to taxes. When you are an employee of a company, they withhold taxes from your pay.The employer then sends the money to the IRS for you. When you are an independent contractor, the company does NOT withhold taxes from your pay.
Being paid as a contractor means that you are have to pay your taxes directly to the government. This can be a nasty surprise on April 15th. Especially if you are accustomed to getting a tax refund every year. Not only will you have to pay your regular income tax, you will also have to pay Self Employment tax. This means you could owe a lot money to the IRS.
Most people are employees and have their wages reported to them on a W-2. Companies are required to send their employees a W-2 before the end of January. Your W-2 form will have a total of how much you were paid during the year. It will also show how much tax was taken out of your pay for the year. If you get a W-2 in January, and have no other income your tax return can be simple. The W-2 form is all you need to file your income taxes. You can use 1040EZ if you don’t have any itemized deductions. If you have a home mortgage or property taxes, use form 1040A. These are simple forms and you might be able to do them yourself with no problems.
If you are paid as a contractor you will get a 1099-MISC form in January instead of a W-2. The 1099-MISC will have the total amount you were paid during the year and that is usually the only number on the form. If you get a 1099 in January, your tax return is going to need a little more work to make sure you don’t pay too much in taxes.
Independent contractor’s who receive a 1099 must use Schedule C. Schedule C is filed with your 1040. If you have 1099’s from more than one business activity you must use separate Schedule C’s for each one. Another thing to remember is make sure you include all your 1099’s. The IRS will match the 1099’s they have for you with your tax return. If the they find one missing, you will get a notice from them.
Completing Schedule C is not too difficult if your bookkeeping is in good order. Just remember that you will also need to complete Schedule-SE. These forms can be intimidating if you have not used them before. If you are unsure how to complete them, use a CPA to complete your tax return.-