When you’re running a small business, and are ready to hire your first employee there are a lot of options: do you want to hire an independent contractor or an employee? While it might seem like this question can be easily answered solely based on your individual business needs and the amount of work you have for the new employee to complete, you also need to consider the tax implications of the classification you choose to give the new hire.
What do the classifications mean?
Independent Contractor: The IRS defines an independent contractor based on the amount of control the employer has over the work being done. Court cases and the Fair Labor Standards Act have further defined “independent contractors” as someone who supplies their own equipment, someone who can choose to come to work or not without fear of losing employment, and a worker that chooses their own hours of employment. Some examples of independent contractors are: lawyers, contractors, and subcontractors.
Employee: The IRS defines an employee as someone “whose employer controls what will be done and how it will be done”. Employees have set hours, clearly defined tasks that are carried out in the manner of their employer’s wishes, and their working materials are supplied by their employers.
What is the difference between an Employee and an Independent Contractor from a tax perspective?
An independent contractor is considered “self-employed”. This means that generally, independent contractors are required to file an annual tax return and pay estimated tax quarterly. They are also responsible for their entire FICA contribution (12.4% Social Security Tax and 2.9% Medicare Tax). In addition, independent contractors are also responsible for securing their own health insurance.
For more information on how to file quarterly taxes, filing an annual return as an independent contractor, and deductions, click here.
An employee is paid with a paycheck, and has the correct taxes withheld. If a person is considered an employee, the employer is responsible for withholding half of the FICA contribution. An employee generally only files taxes annually.
If you’re ready to hire, we suggest taking a look at our guide to writing an offer letter. Make sure you include what type of hire (independent contractor or employee) the new person will be! Did you enjoy this article? Visit insights
These free resources should not be taken as tax or legal advice. Content provided is intended as general information. Tax regulations and laws change and the impact of laws can vary. Consult a tax advisor, CPA or lawyer for guidance on your specific situation.