CARL WATTS & ASSOCIATES

October 12, 2015

www.carlwatts.com
office@carlwatts.com
Washington DC
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We all need them and employ their services rather frequently, but who are they more precisely? How are independent contractors defined? And, more importantly, how are they treated like from the taxation point of view?
From the legal point of view, an independent contractor is a person who contracts to do work for another person according to his or her own processes and methods; the contractor is not subject to another's control except for what is specified in a mutually binding agreement for a specific job.

They are sometimes called consultants, freelancers, self-employed, and even entrepreneurs or business owners. The term sole-proprietor, for instance, is a tax category for federal income tax purposes. You can very well be an independent contractor and file taxes as a sole proprietor.

Unlike an employee who works for one employer, independent contractors typically work for a number of different clients, tackling particular jobs or projects that require special expertise.

The IRS specifies that people such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors.


However, whether these people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.


The IRS have developed one comprehensive test that takes into account agency-law criteria and numerous other factors courts have created to define independent contractor status. Known collectively as the 20-factor test, the enumerated criteria generally fall within three categories:

  • Control (whether the employer or the worker has control over the work performed),
  • Organization (whether the worker is integrated into the business), and
  • Economic realities (whether the worker directly benefits from his or her labor).

The 20 factors serve only as a guideline. Each factor's degree of importance varies depending on the occupation and the facts involved in a particular case.


Let us see now what tax obligations there are for contractors and for people hiring independent contractors.

If you are an independent contractor working for someone else you must sign Form W-9 at hire, providing a taxpayer ID number (Social Security Number, Employer ID, or other).

If the employer of an independent contractor doesn't have a valid tax ID on file, the employer must withhold taxes from payments made to the contractor. If a valid tax ID is provided, no federal income taxes need to be withheld from the contractor's payments.

Independent Contractors

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For income tax reporting, as an independent contractor you usually receive Form 1099-MISC at the end of a year from each company for whom work is done. The 1099-MISC shows income and any withholding (usually none, unless backup withholding is required). Since independent contractors are self-employed, you will have to file income taxes on Schedule C, unless a different business type has been selected. On Schedule C you can deduct from your taxable income any necessary expenses related to your business, as long as they are reasonable in amount and ordinarily incurred by businesses of your type.

As an independent contractor, unless you pay income taxes through backup withholding, no taxes have been paid during the year, so you must make estimated tax payments each quarter.


Because an independent contractor is not an employee and does not receive a paycheck, no Social Security and Medicare taxes are withheld from payments. So the independent contractor must pay self-employment taxes at the end of the year, along with his or her personal tax return.

If you pay independent contractors, you may have to file Form 1099-MISC, Miscellaneous Income, to report payments for services performed for your trade or business. If the following four conditions are met, you must generally report a payment as non-employee compensation.

  1. You made the payment to someone who is not your employee;

  2. You made the payment for services in the course of your trade or business (including government agencies and nonprofit organizations);

  3. You made the payment to an individual, partnership, estate, or in some cases, a corporation; and

  4. You made payments to the payee of at least $600 during the year.

You must keep track of payments you make to independent contractors each year. You do not need to withhold FICA taxes (Social Security and Medicare tax) from these payment. But, for each independent contractor you paid $600 or more during the year, you must report to total amount paid on Form 1099-MISC Box 7 and give a copy of this form to the contractor for his/her income taxes.



The 1099-MISC must be given to the contractor no later than the last day of January the following year.

Form 1099-MISC, Miscellaneous Income, is transmitted with Form 1096, Annual Summary and Transmittal of U.S. Information Returns, which is similar to a cover letter for your Forms 1099-MISC.

Non-employee compensation paid to nonresident aliens is reported on Form 1042-S, Foreign Persons' U.S. Source Income Subject to Withholding, where some withholding may be required.

Whether you employ independent contractors in your line of business or are an independent contractor yourself, advice from a tax professional may prove invaluable in all your dealings with the IRS.