Tax Implications of Choosing Between Employees or Contractors

For small business owners, choosing between hiring employees or contractors is an important decision that defines not just working relationships, but taxation as well. While it’s wise to base your hiring decision on the type of working relationship you desire, you should also be aware of your tax responsibilities in either case.

First, you should understand the difference between an employee and an independent contractor. An employee is anyone who performs services for you, but you have the right to control what will be done and how it will be done. Independent contractors also perform services for you, but you cannot control how the task will be done, only the end result. Independent contractors charge higher fees for specialized services, use their own materials, regulate their own work plan, and are more likely than employees to have un-reimbursed business expenses. Employees stay with you past the completion of individual projects.

Because of these differences in the working relationships of employees and contractors, there are major differences between their payroll taxes.

For employees:

• You must withhold state and federal income tax
• You must withhold Social Security tax
• You must withhold Medicare tax
• You must pay Unemployment tax on wages
• You must complete a W-2 form for each employee

For independent contractors:

• You generally do not have to withhold or pay taxes ?-there are typically fewer reporting requirements
• You may have to file information returns (form 1099-MISC) to report certain types of payments made to independent contractors.

If you misclassify employees as independent contractors on your tax return, you’ll be liable for paying employment taxes for that worker, so double check all Employment Agreements and Independent Contractor Agreements to be sure of your working relationship.

For more information about business taxes, go to www.irs.gov.

Laws on this topic may vary from state to state. This content is not meant to provide you with complete information and it is not intended to be legal or tax advice. It is recommended that you consult with your own attorney, accountant or other advisor regarding your specific situation.