Independent Contractor Nightmare
Are You an Independent Contractor or an Employee?
There are two types of worker classifications in the United States, an independent contractor and an employee. Do you know where you stand? Prior to the pandemic, it was a little clearer, perhaps, and we all relied on the interpretation of the IRS.
Now with the changes created by COVID-19, many workers are not traveling to their employer’s office. Instead, they work from their homes and submit their work to their employer by computer.
Many others, who have lost their jobs because of the virus, take on part time work, working as independent contractors. Can you guess why so many employers classify these workers in that way? Yep, to reduce costs.
One state, California, has passed a law that classifies most workers to the status of being an employee, with exceptions in the entertainment industry. This has not been sitting well with employers, and further challenges to this law are in the offing.
Basic understanding of the two classifications
Working as an employee, your employer must withhold Social Security and Medicare taxes at the rate of 7.65%. The employer then must pay an equal amount to the IRS as their portion. Also, the employer will withhold federal and state income taxes for you. At the end of the year, you will be issued a Form W-2 to report your earnings.
In addition to the taxes, most employers offer a benefits package that could include medical insurance, retirement benefits, sick leave, and other benefits, all at a big cost to the employer.
Working as an independent contractor, you are required to pay self-employment tax on your gross income, less applicable expenses. This tax is the full 15.3%, but reduced a little by an additional calculation.
Plus, income taxes that you will owe must be paid by filing estimated tax payments for the IRS and your resident state. Sometimes, you will owe taxes to another state too, if the payer of your funds was in a different state. This is being watched carefully by most states, because of their dire need for additional revenue.
As a self-employed individual, you won’t be getting any benefits paid on your behalf. You will need to buy your own medical insurance, and also provide for your retirement.
Consider these issues
You, as a worker, will generally benefit more by being classified as an employee. However, you don’t always have the final say. Some companies, trying to lower payroll costs, will attempt to classify workers as independent contractors. There are a number of factors the IRS uses to determine if you are an employee or an independent contractor.
But basically, if the employer has control of your work by saying how, when and where the work is performed, you are probably an employee. This, too, is being watched by the IRS, and severe penalties are being issued to those companies that don’t follow these rules.
Be aware of your obligations
Due to the large number of workers being classified as an independent contractor, you must take good care to handle your tax filing obligations in a timely manner. Starting with the 15.3% self-employment tax, for Social Security and Medicare, it’s very important to keep them current.
If you get behind in paying this tax, you are going to be in for a financial nightmare that you may never recover from. To make matters more confusing, you may think you’re being paid as an employee, and when you find out just the opposite, some taxes may already be late in filing.
You need to clarify your classification status up front, and make sure of the possible second state tax liability. The second state tax liability can affect an employee as well. Pay all of these taxes when they are due if you are an independent contractor, and when its time to file your tax return, you’ll breeze right thru it.