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Do You Process Contractors' Paychecks Differently from Those of Regular Employees?
If you don't want to risk turning independent contractors into employees in the eyes of the IRS, make sure to pay them differently.
If you don't want to risk turning independent contractors into employees, you definitely should pay them differently. Employees are generally paid in units of time: hours, days, weeks, months and so on. Independent contractors are typically paid on a project basis or by commission, although some are paid by the hour (psychiatrists and attorneys). All things being equal, a worker paid in units of time is more likely to be deemed an employee than an independent contractor.
An employer must also withhold income tax, Social Security, Medicare and unemployment tax from employee wages. Independent contractors, however, are responsible for paying their own taxes and insurance. At the end of the year, payments to employees are reported on the W-2 form, whereas payments to independent contractors are reported on the 1099-MISC form.
It's important to understand and observe these and other legal and practical distinctions between employees and independent contractors. There are potentially serious financial consequences if "independent contractors" are later found to be "employees." The employer could be liable for unpaid taxes, insurance, severance pay and other employee benefits for wrongfully classifying "employees" as "independent contractors" (as Microsoft recently discovered when it lost its legal battle to prevent scores of temporary workers from being reclassified as employees).
While no single factor rules, the IRS (or a court in the event of a lawsuit) will certainly consider payroll treatment of "independent contractors," should a question arise about whether a particular worker or group of workers was properly classified. See IRS Advice on Independent Contractors vs. Employees for more information.
Get more information on salary and compensation and employee benefits at AllBusiness.com.
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