Employee vs. Contractor Taxes
As a business owner, it’s such an exciting time when you get to hire your first employees. You’ve really hustled and grown your service-based business to a small empire. And now you need some help to take it to the next level!
But should you hire an employee or a contractor?
There are some big differences between the two. This article will cover those differences and tell you how to handle employee vs. contractor taxes.
Employee: Your Go-To Guy
This is the type of worker you are probably most familiar with and the type of worker you’ve probably been yourself!
Full-time employees work for one employer and are duty-bound to follow that employer’s policies and procedures. You as the employer sets the terms of their work: hours, location, and job duties are all decided by you, the business owner.
In addition to a salary, you typically provide your employees benefits, like health insurance and 401(k) retirement plans. Employees are protected legally under anti-discrimination and workplace environmental laws at both the federal and state levels.
Contractor: The Independent Helper
Independent contractors work for you but are not under your “control” like employees are. Contractors set their own hours, provide their own equipment, and often have multiple employers they work piecemeal for.
When their work is finished, they will send you an invoice for their payment, unlike employees who you will have to provide a regular paycheck to.
Employee vs. Contractor: The Common Problem
Even though the differences between employees and contractors can seem pretty stark, you’d be surprised how many business owners get in trouble for mixing up the distinction!
A common issue that gets business owners into trouble is when they try to game the system and classify employees as independent contractors. Because contractors not employees, employers are not forced to pay them overtime if they go over their agreed upon hours. Employers do not have to pay employment taxes for contractors, nor do they have to abide by discrimination and employment laws.
Abusing the system by classifying what would be employees as contractors to nab some quick savings has gotten employers into very serious trouble. Intentionally misclassifying employees is a federal offense! On top of the federal charge, rule-breaking employers can expect hefty fines and big lawsuits.
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Employee vs. Contractor: Taxes & Tax Forms
Taxes
As the owner of a service-based business, taxes are going to be the biggest difference you experience between your employees and your contractors.
You have a LOT more responsibility when it comes to your employees and their taxes. Employers take both income and employment taxes out of their employees’ paychecks.
- Federal and state* income taxes are calculated and withheld from each paycheck.
- Employment taxes (also called FICA taxes) are Social Security and Medicare taxes that you must deduct from each employee paycheck. The employer matches the employee amount, and both pieces are turned over to the government.
Independent contractor taxes are much easier to figure out as the business owner – because there aren’t any! You do not have to withhold any FICA or income tax from contractor payments. Independent contractors pay their own self-employment and income taxes on a quarterly basis.
*Note: The following states do not have any state income taxes, so you’d only have to worry about the federal income tax withholding for employees if you live in one of these states: Wyoming, Washington, Texas, Tennessee, South Dakota, Nevada, Florida, and Alaska.
Tax Forms
Service-based business owners know that tax time is stressful because of the amount of paperwork required to get your house in order. In comparing employee vs. contractor tax forms, they are different but about the same amount of work as the employer.
Employees receive Form W-2 from you, their employer, by January 31st. This form provides them with their wages earned, any retirement contributions paid, withholding amounts, and other related tax info. It can be pretty daunting to collect, analyze, and fill out these forms – especially when you have a lot of employees – so we’d suggest utilizing a tax pro to get these together for you.
Contractors will provide you, the business owner, with Form W-9 when you hire them on. At year-end, you must issue them Form 1099 which summarizes all the payments you’ve sent them that year. It can be easy to forget this step when you’re in the throes of year-end paperwork. But definitely get those 1099s out to all of your contractors, as not issuing them can make the IRS flag you for an audit.
As you can see, there are some big differences when it comes to employee vs. contractor taxes. We hope this article gave you some much needed info on the distinction between the two types of workers, but if you need a little extra help – you know where to find us!
