Most small businesses begin with just the founder and sometimes operate that way for years. When it is time to expand operations and begin hiring additional employees, owners are often stuck with a critical decision: W-2 workers or 1090 workers?
There are many benefits to hiring independent contractors (ICs), as well as some disadvantages. The important question most small business owners ask when hiring for the first time is whether or not hiring contractors will help lower taxes.
Independent Contractors vs. W-2 Workers
Organizations have the option of hiring W-2 workers or independent contractors. However, you cannot simply decide which way you want to handle taxes and go that route.
Independent contractors are different for a reason. They technically have an association with the company, yet not nearly in the same way as W-2 employees. First, let’s examine the differences in how they are classified with the IRS. Then, we’ll examine how the relationship must coexist with small and medium businesses (SMBs):
● Independent Contractors: As the name implies, the contractor is technically associated with the company to provide a service, but is not a full-fledged employee of the SMB. As a result, the independent contractor receives a lump sum payment for services and Social Security and Medicare are not withheld from the earnings. As a result, self-employed individuals and freelancers must report their income and pay taxes in quarterly installments or at the end of the year on their own.
● W-2 Employees: Traditional employees who fill out forms at the start of employment to have Social Security and Medicare automatically deducted from each paycheck, along with federal and state taxes, are considered W-2 employees. At the end of the year, they receive a W-2, which explains how much in tax withholdings they had for the year.
Now, let’s examine the employer and employee relationship:
Independent Contractors (ICs): The general rule is that employers only have control over ICs related to the results of their work. However, the employer cannot dictate how the work will be completed and what will be done. In short, ICs have more leeway compared to traditional workers regarding how and what they get completed.
W-2 Employees: In general, W-2 employees have much higher obligations to employers. The employer can not only control or direct the result of the work, but also how it is completed and what rules need to be followed. W-2 employees have less flexibility than independent contractors. So, if you want control over methods for how work gets done, you should classify the worker as a traditional, W-2 earner.
Benefits of Employing Independent Contractors
So, why would you hire ICs instead of traditional W-2 workers? Most importantly, you will probably save money.
Yes, independent contractors generally get more per hour compared to traditional workers doing the same work. However, it usually costs employers more to hire employees because of taxes and paid benefits, equipment, etc.
There is also the pressure to make sure you are withholding the correct amount of taxes on each paycheck and are paying the IRS on designated deadlines.
Employers that hire W-2 workers must:
● Withhold the employee’s share of Social Security and Medicare.
● Pay state unemployment compensation insurance.
● Pay worker’s compensation insurance.
Accountants claim that altogether, opting for independent contractors over traditional hires can save you approximately 20 to 30 percent on payroll costs and other employee expenses like benefits.
Hiring Independent Contractors & SMB Taxes
Contracted workers have to pay self-employment tax. As a result, they cover their tax liability, which is typically the responsibility of an employer for traditional hires.
Additionally, independent contractors are not covered under most federal employment statutes. There is no requirement to cover benefits, withhold taxes, pay for family or medical leave, or pay for legal fees.
Furthermore, SMBs can save even more money by deducting wages paid to independent contractors from your taxable income. In order to do so, you need an IRS 1099-MISC sent to ICs as well as provide the IRS Form 1096 on your personal return.
Hiring Independent Contractors is Less Risky for SMBs
There is no doubt about it, there is less risk and likely less money spent on independent contractors vs. traditional hires in the long run.
Independent contractors don’t require employers to do much and they assume more tax liability.
The biggest concern for employers is making sure employees are correctly classified as 1099 workers and not W-2 workers.
As a result, we recommend you reach out to a tax professional if you deal with independent contractors. Levy & Associates can make sure you aren’t using any illegal write-offs and remain in good standing with the IRS. Hiring ICs vs. W-2 workers can potentially save you 20-30 percent on payroll costs and even more in tax benefits.
To set up a free, initial consultation please visit www.levytaxhelp.com or call 800-TAX-LEVY.