As companies expand, they often search for more workers to complete important and necessary tasks. Businesses can either bring on employees or independent contractors during this endeavor. It’s crucial for human resources teams, however, to understand the differences between these choices as well as the payroll tax implications of each classification.
Employee vs. independent contractor
There are many key points that separate regular workers from contractors. The criteria for an independent contractor is as follows, according to the U.S. Small Business Administration:
- Operates under a business name.
- Has his/her own employees.
- Maintains a separate business checking account.
- Advertises his/her business’ services.
- Invoices for work completed.
- Has more than one client.
- Has own tools and sets own hours.
- Keeps business records.
In addition, employees are required to receive benefits and are covered by discrimination and harassment laws. Independent contractors are not entitled to the same treatment and are often seen to offer reduced liability to organizations during the recruitment process. While employees receive training for their duties and their responsibilities are dictated by their employer, independent contractors operate individually and are not legally bound by the hiring organization to perform their obligations a certain way.
Accurate classification is necessary
Companies and their HR staff must familiarize themselves with the distinction between independent contractors and employees for proper reporting. Failure to accurately file for the different types of workers could have expensive consequences for businesses. Companies that falsely classify an employee as an independent contractor will have to provide the entitled benefits and reimbursement for extra pay, including minimum wage or overtime.
“Misclassifying independent contractors can have costly consequences.”
Separate payroll for thorough accounting
Once HR teams have appropriately classified their workers, they must understand the specific payroll tax requirements for each party. Since independent contractors are technically self-employed, companies do not have to withhold taxes such as Medicare, Social Security, federal income tax or state and local taxes, according to The Houston Chronicle. However, businesses must take these elements from a regular employee’s earnings.
While organizations are required to distribute both a W-2 and a W-4 to their part- and full-time employees, independent contractors should receive a W-9 to complete with their name and tax identification number. Companies that hire independent contractors must also fill out a 1099 form for paid services that cost $600 or more, according to the IRS.
The differences between an employee and an independent contractor can be difficult for businesses and their HR personnel to comprehend, but knowledge of the separate classifications is necessary for accurate disbursement of wages and proper tax filings with the IRS. Understanding the characteristics of each categorization will ensure organizations avoid costly consequences.