Paying an Independent Contractor

Paying an Independent Contractor

When it comes to compensation for services rendered, paying an independent contractor is far less burdensome than paying an employee.

Paying Employees is Burdensome

It makes very little difference whether you have one employee or thousands, state and federal governments require a significant amount of record keeping, bookkeeping, and on-time tax deposits. First, employers are required to withhold from the employee’s pay state and federal income taxes – which must be calculated based on the employee’s earnings and the number of exemptions claimed on form W4. The payer must also withhold one half of the total social security and medicare taxes from the employee’s pay. The maximum amount of social security to withhold changes annually.

The employer is then obligated to deposit taxes withheld on a regular bases, depending on the amount withheld. Most states have followed Federal precedence in requiring deposits to be made electronically using the taxing authority’s website. Completing the enrollment process to be an authorized user on these sites can be quite time consuming. In addition to depositing the payroll funds withheld, employers must kick in the other half of the employee’s social security and medicare taxes as well as make regular state and federal unemployment insurance payments which are based on many factors including total wages and the employer’s industry. The employer’s payroll tax burden will vary by state, but can easily be 18% or more in addition to the employee’s wages.

Record Keeping for Independent Contractors

For these reasons businesses love to hire contractors. Paying an independent contractor in most cases is as simple and straight forward as cutting a check, just as if purchasing paper at the local office supply store. In most cases there are no taxes to withhold, no additional government-mandated costs to consider, and very little reporting required. However, there is some record keeping to do before and after paying an independent contractor:

  • Though the government-mandated record keeping for contractors is significantly less than that which is required for employees, there are two forms that are essential. The first is a W-9 which provides to the business the contractor’s pertinent information including address and social security number or EIN. The W-9 does not need to be filed with the government, but it does need to be kept on file. If a contractor does not provide a W-9 to the employing business or the information on the W-9 is incorrect, the employing business is required to withhold 28% of all payments a backup withholding. Backup withholdings must be reported to and deposited with the IRS in a manner similar to reporting and depositing payroll tax withholdings.
  • The second form – which does get filed with state and federal governments – is the contractor’s 1099. This form is a summary record of all the payments made to the contractor, whether for labor, materials, or any other reason. If the total compensation paid to the contractor is equal to or greater than $500, a 1099 is required.

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Paying an Independent Contractor a Matter of Agreement

Independent contractors are, by definition, not employees. Paying an independent contractor, therefore, is not subject to the same issues as when paying employees – which will be governed by the company’s HR policies and state and federal employment law. The compensation of contractors is governed by a written or verbal contract between the business and the contractor and to some extent commercial law. It is therefore important to fully articulate the terms of the working relationship between contractor and employing business including, but not limited to:

  • The contractor’s basis of pay. Contractors may work on an hourly basis, on a per-piece basis, per the job, or any other basis mutually agreed upon by the parties.
  • Type and timing of payments to be made. Some contracts may stipulate progress payments, materials payments, fees, reimbursable expenditures, or other terms.
  • Type and timing of deliverables. Contracts should also specify when work is due, the standards or definition of acceptable work, how and where work is to be delivered or performed.

Can You Pay an Independent Contractor?

There are very specific rules for determining whether a worker is an independent contractor or an employee. Determining the worker’s status is in no way dependent on any agreement between the worker and the employing business – it is a matter of legal interpretation of subjective considerations. Misclassifying workers as independent contractors can subject the employing business to backup tax liabilities, interest, fines, and penalties. While determination of worker status is done on a case-by-case basis, a primary consideration is that of economic independence. The independent contractor must be able to satisfactorily demonstrate that he or she is not economically dependent of the employing business. Both IRS regulations and the Department of Labor publications consider workers to be employees by default.