Taking On an Independent Contractor? How Do Taxes Work?
It’s not that complicated, but you need to know the IRS income tax requirements for independent contractors.
When it comes to dealing with income taxes, it’s a lot easier to hire an independent contractor than an employee. But first, you need to make sure you understand the difference clearly. The IRS makes the distinction on this page. If the agency’s rules are unclear to you, we can help you distinguish between the two classifications.
If you’re sure the individual you’re hiring is indeed considered self-employed, there’s good news. Your tax obligations are far less complicated—and expensive—than they would be for an employee.
We’ll take a look at what you’re required to do and the forms both you and your new hire must complete.
Saving Money and Time
Individuals who earn more than $600 from you must complete a Schedule C and submit it with their Form 1040. They’re required to pay quarterly estimated taxes on that income. When they file their annual taxes, they’re charged with paying the payroll taxes that employers normally pay for actual employees. This is called the self-employment tax.
So you’re off the hook for those onerous payroll taxes when you hire an independent contractor. Your only obligation (besides paying them) is to provide them with the required IRS forms.
What Is the W-9?
Before you start paying an independent contractor, they need to fill out the Form W-9 and return it to you.
If you’ve ever worked a W-2 job, you’ll probably remember that you had to fill out a W-4 form. Independent contractors must complete a Form W-9, as pictures above (you can find a copy here). Contractors can either hand you a printed copy or scan and email it if they’re remote workers. You’ll use the information provided when you report their annual income. You should keep copies of these for at least four years in case a question comes up down the road.
The W-9 is quite a simple document. Your new hires needs to provide:
● The name that appears on their tax return,
● Their business name, if different,
● Their federal tax classification (like Individual/sole proprietor or single-member LLC),
● Their address,
● Their Taxpayer Identification Number (TIN), which is either a Social Security Number or Employer Identification Number (EIN), and,
● Their signature and date.
What Is a Form 1099-NEC?
You won’t need to worry about this until the end of the year.
Up until 2020, nonemployee compensation was reported on the Form 1099-MISC, along with a lot of other miscellaneous types on compensation. Now, you must complete a Form 1099-NEC for services performed by someone who is not your employee if you paid him or her at least $600 during the tax year. This, of course, includes independent contractors (also, payments to an attorney).
The 1099-NEC is no more complicated than the W-9, but double-check your work for accuracy because your independent contractors will use its information for their tax returns. It must contain:
● The calendar year (upper right corner),
● Your name and address and the recipient’s,
● Your TIN and the recipient’s, and
● The total dollar amount of nonemployee compensation.
The rest of the fields here are optional. See the 1099-NEC instructions if you have questions.
A partial view of Copy 1 of the Form 1099-NEC
You can find the 1099-NEC here, but be sure to read the IRS instructions. You will need at least three copies: one for the IRS and two more for your state tax department and the independent contractor. You can print the latter two from the link mentioned above, but you can’t print the IRS copy (shown in red) because it needs to be scanned by the agency. You could face penalties for doing so. Get more information about ordering IRS forms here.
If you’re filing ten or more returns, you must e-file them (as of tax year 2023). The IRS has set up a free web-based service that supports this: the Information Returns Intake System (IRIS) Taxpayer Portal. You can find more information here. If you have fewer than ten and will be submitting them on paper, you must also send in a Form 1096, Annual Summary and Transmittal of U.S. Information Returns. You can find it here. Here again, you can’t print and submit this web-based form, but can order acceptable ones here.
Still Have Questions?
Adhering to the income tax requirements for independent contractors isn’t overly complicated, but let us know if you still have questions – especially about the critical employee vs. independent contractor classification. You must get that right. As always, we’re here to help you with both tax planning and tax preparation.
