Independent Contractors and Tax Compliance

Tax Professionals' Resource
February 18, 2013 — 3,165 views  
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Independent contractors (ICs) are individuals who are self-employed. There are independent contractors across a wide variety of industries and sectors. They work under the control of a company or corporation.

Their work is based on contracts with companies, but they are not considered to be employees of that company, and they do not receive benefits from them. They usually have their own insurance, disability, and retirement plans.

ICs follow different statutes outlined by the Internal Revenue Service (IRS), unlike regular employees. If they do not succeed in following these tax laws, they can be subject to serious fines and penalties. Many business owners fail to comply with the IRS rules outlined specifically for ICs, and this leads to serious consequences in the future. It is therefore very important to understand the difference between Independent contractors and employees to ensure tax compliance.

Tax Liability

When companies sign contracts with ICs, they are not liable to pay taxes on the contractor’s behalf. However, there are many issues that are meant to protect the employers who hire independent contractors. These issues mainly deal with the issuance of 1099 Form to ICs by employers. It falls to the accountants who deal with company funds or who work for independent contractors to ensure these forms are filed on time and when needed.

Form 1099-MISC is a necessity when businesses hire non-corporate service providers who were paid a minimum of $600 for their services in the previous year. Form 1099-MISC is not required if the independent contractor was paid electronically, such as via debit card, credit card, PayPal, or a gift card. The company that makes the payment (for example, the concerned credit card company) will send all the necessary forms to the IC.

Benefits and Precautions

There are advantages to hiring independent contractors. They are experienced professionals who assist large businesses with short-term projects. They are also extremely useful to companies that are facing staff shortages or those who want to complete projects without hiring long-term employees.

It is the responsibility of the person in charge of accounts to ensure the compliance with all tax regulations outlined by the IRS, when it comes to ICs. Keep the following in mind when dealing with independent contractors:

  • The IC should have all the necessary basic information about tax liabilities. Though most ICs are familiar with their tax and insurance requirements, those who are new may be confused as to who pays their taxes. Make it clear to the IC that the company who hires them will not be liable to pay their taxes.
  • State clearly when the 1099 Form will be issued to the IC, if applicable. While independent contractors are expected to pay taxes by mid-April, many choose to make quarterly payments to avoid penalties. They need to be given the 1099 Form on time; failure to do so could result in hefty fines to the employer who has hired them.
  • Advise business owners to sign clear contracts with ICs. If there is a situation where an independent contractor doesn’t insist on signing a work agreement, reconsider whether to work with that individual. A contract defines the relationship between an IC and an employer, and lays down the ground rules that serve to protect both parties.

It is important for accountants working for either the independent contractor or the businesses who hire them to know how to comply with taxes regarding ICs. Businesses who hire ICs aren’t responsible for filing for their taxes, but they are responsible for providing them with the correct documentation when the situation calls for it.

Tax Professionals' Resource