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Wage Earners vs. Independent Contractors
Section 530(e)(3) of the 1978 Internal Revenue Code allows for employers to not be responsible for paying an employees taxes if certain requirements are met by the business and there is a relationship between the business and an employee.
Wage Earner
Wage Earners have taxes deducted from their pay as shown on their paycheck stubs or pay statements. Employers are required by law to deduct monies for Social Security, Federal Income Tax, and Medicare payments. Employers are then obligated by law to send in those monies to the Internal Revenue Service. If for some reason an Employer does not send in a Wage Earner’s taxes, the Employer only will be held liable as long as the taxes were deducted from the employees pay. Employees will receive a W-2 form at the end of the year documenting the amount that was withheld for tax purposes.
Independent Contractor
Independent contractors do not have taxes taken out of their paycheck or monies received. Independent contractors must pay taxes on their own initiative through estimated payments (ETPs). Estimated payments are due quarterly but can be required on a more frequent basis.
Smaller business like independent contractors often do not make estimated payments. As a result, they often owe taxes at the end of every year. Independent contractors often work for various different companies and people, but can also work for only one company. Generally, independent contractors are paid on “a per job, work performed” basis. If an independent contractor receives a tax statement from an employer, it will be on a Form 1099.
Distinguishing an Independent Contractor vs. Wage Earner
Normal Paycheck stubs
Normal Paycheck stubs will clearly show deductions for taxes (Federal income, Social Security, Medicare and/or State and Local taxes), other deductions and year to date amounts for all categories.
Form 1099
With a Form 1099, a worker does not have any taxes taken out and is regarded as an independent contractor. An independent contractor should make estimated payments.
Other unique situations with 1099 employees are:
• a worker does not have a Form 1099 for himself or herself
• a worker pays other workers from the income he or she receives (team lead for farm work) but has not given the workers he pays Form 1099s
• a worker has personal checks written out to him or her and/or is paid in cash
Tax Implications
Wage Earner
Wage Earners need to have sufficient taxes taken out of their paychecks. If a wage earner claims too many deductions on a W-4, he or she will owe taxes at the end of the year. If this occurs, the IRS might forcibly dictate the amount of deductions or taxes to be taken from the wage earner’s pay.
All wage earners should talk to their employers or accountants to make sure the correct withholdings and deductions are used. Because when a wage earner owes taxes every year, it can be a lot harder to resolve his or her tax debt with the IRS.
Independent Contractor
When does an independent contractor need to pay estimated taxes? If a wage earner expects to owe at least $1,000 in tax for 2009 after subtracting withholding and credits, and he or she expects his or her withholding and credits to be less than the smaller of:
• 90% of the tax to be shown on his or her 2009 tax return, or
• 100% of the tax shown on his or her 2008 tax return. The wage earner’s 2008 tax return must cover all 12 months.
Source: RoniDeutch.com
