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For all intents and purposes, the IRS treats a contract worker, often referred to as a 1099 worker, as self-employed. Form 1099Typically, a contractor receives his full pay without any taxes withheld from his paycheck.
TaxesAs a self-employed person, you are responsible for paying 15.3 percent self-employment tax, which is your contribution to Medicare and Social Security tax. InsightEmployers who hire contract workers do so to avoid the added cost and responsibility of collecting payroll taxes. Veteran contributing editor Kay Bell writes Bankrate's tax stories from her Austin, Texas, home. We'll help you understand the extremely complicated tax code in easy-to-understand language. Our tax expert Kay Bell provides resourceful tips and advice to help you stay prepared for filing. Contract workers typically have control over the conditions in which their perform their services.
Misclassifying a legal employee as contract labor can be a costly mistake for a small business.
ControlThe amount of control you can exercise over the worker is one of three factors the Internal Revenue Service examines to decide the proper classification.
OverallNo single aspect of any of the three categories automatically makes a worker your employer or a contractor. TaxesIf you determine that the worker is a contractor, you do not withhold income tax, Social Security or Medicare taxes unless you do not have a Form W-9 for the worker or have been notified by the IRS that he is subject to backup withholding. Backup WithholdingIf you do not receive a W-9 from a contractor, or if his taxpayer identification number is missing or invalid, you must immediately begin withholdings. Independent Contractors have been a common addition to many organizations for years, but have increased in use over the past several years as companies have shed their staff headcount.
The use of Independent Contractors is cost effective for organizations as the employer is not burdened with withholding payroll taxes, making matching payroll tax contributions, or covering the cost of the employee’s health and retirement benefit plans. Additionally, opting to allow an Independent Contractor’s contract to expire if he or she is not a good fit for the organization is a simpler task than terminating a regular employee of the company. If you are a business owner or contractor who provides services to other businesses, then you are generally considered self-employed. It is extremely important to note that the IRS does not allow all workers to be classified as Independent Contractors.
The IRS uses a 20-step statutory test to determine whether an individual should be classified as an employee or contractor. As a contract worker independent from the company's direct control, you must pay your own taxes income taxes including Medicare and Social Security taxes, or your part to the Federal Insurance Contributions Tax Act (FICA).
Regular employees also pay Medicare and Social Security tax, which amounts to 7.65 percent.

That means that in addition to the holiday shopping season, the holiday hiring season is about to begin.Each year, companies add more workers to handle the seasonal customer crush.
If you dictate how the worker must accomplish a given task and what steps he must take, you likely have an employee rather than a contractor. If the worker is going to continue to work for you and perform duties that are critical to your continued operations, he may be your employee.
You might even have contradictory evidence, such as a long-term relationship with a contractor providing key benefits to your company who furnishes all of his own equipment. You do not include his wages when determining your liability for unemployment taxes, and you are not liable for the employer portion of Medicare and Social Security. You must also comply with any instructions received from the IRS indicating that the contractor is subject to backup withholding. Independent Contractors are secured either directly and work in a 1099 capacity or they are brought into an organization via the route of a third party staffing or placement agency. Additionally, this is a great opportunity to see if an Independent Contractor will fit in with the organization’s culture as well as whether the individual will be successful in the role for which he or she was contracted. Some disadvantages, though, are that the employer has substantially less control over an Independent Contractor. If you are a business owner hiring or contracting with other individuals to provide services, you must determine whether the individuals providing services are employees or Independent Contractors and ensure that the workers are categorized in line with their status.
The IRS has strict guidance regarding the classification of W-2 Employees verses 1099 Independent Contractors. If a contract employee falls outside of this definition, she receives treatment as an independent worker and separate from such company benefits as medical, disability and worker's compensation.
In some cases, companies fraudulently classify a worker as contract worker to eschew their responsibilities. Knowing how to determine whether a worker is a true contractor or your employee is the first step. Contractors generally have the right to decide the order of operations involved in completing a task and the best way to accomplish the job. This is not to say that a contractor could not be given a ream of printer paper or use the office copy machine. On the other hand, if you have a written contract specifying the task to be accomplished without dictating the exact method of accomplishing the task, you might have a contractor. Contractors are responsible for paying their own self-employment tax, which is a combination of the employee and employer contributions to Social Security and Medicare. As of 2012 the backup withholding rate is a flat 28 percent of all payments you make to the contractor.
Independent Contractors who find success in their roles and fit in well with a company’s culture hold an advantage should they be hired to become regular employees of an organization as their learning curve is substantially shorter than that of an individual who is hired into the company from the outside. In addition, an Independent Contractor will not have the loyalty to the organization as would a regular employee.

The basic premise behind the determination is the amount of control that the company has over the worker and how the work is performed. Therefore, it is critically important to ensure that workers are not misclassified as 1099 Independent Contractors when they should be W-2 Employees. Unlike an employee who has payroll taxes deducted from his paycheck, a contract employee is responsible for paying his own taxes. Once you know that a worker qualifies as contract labor, you can then follow the proper tax laws.
Look at indicators such as whether you have to train the worker to do the task you hired him to do, pay his health insurance or allow him to participate in your company’s profit-sharing plan.
The Independent Contractor has already had an opportunity to become acquainted with the organization’s industry as well with the dynamic of its employees.
Another large contributing factor is how important to the work is to the company’s core business. Misclassification could result in substantial back taxes, IRS penalties, liability for workplace injuries, retroactive benefits, attorney’s fees, and other monetary damages. The IRS advises the self-employed to pay the FICA and income taxes throughout the year, thereby reducing the tax liability when it's time to file taxes.
There's no need to pay benefits for contractors, and companies can also save on taxes because it's not necessary to pay the employer portion of Social Security and Medicare or state unemployment taxes.In most cases, companies follow the law, says Sally Herigstad, a Kent, Washington-based CPA and author of "Help!
As a rule, you are only required to issue a 1099 to contractors who receive more than $600 in wages from you during the calendar year.
With an Independent Contractor, employers do not have the same incentive to retain and train these workers as they would a regular employee of the organization. And an employee works for only 1 boss.An independent contractor, on the other hand, generally has several clients. A contractor has his or her own tools (and in the modern workforce, this means digital devices, not just hammers and wrenches) and sets his or her own hours. That, along with withholding of income tax (both federal and state) is why the $9 an hour at the fast-food place comes to less each payday.But as an independent contractor, you pay 100% of the FICA taxes when you file your tax return.
Any amount you earn is legally taxable and you should report it, either on Schedule C or as other income on Form 1040."You may make just $10, but it's still taxable," says Herigstad. But you don't owe SE taxes unless you netted more than $400 from all contracting jobs in a tax year.Employee vs. The business gets to decide whether to carry you on the books as an employee or contractor.The length of time you work -- for example, a few months over the holidays -- doesn't matter, says Herigstad.

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