By Deanna Parmenter
This blog is the final in a series talking about basic accounting concepts that I frequently get asked about.
You finally get the call you were waiting for…someone wants to hire you to do a job for them. You agree on a rate and when the job will be completed. Ready to start? Not so fast.
Employers do not like to hire employees unless they have to because this means they have to pay payroll taxes on that person’s wages. Employers must withhold your federal income tax, your portion of social security and Medicare taxes. They also must match your social security and Medicare tax payments, and pay into the state’s unemployment fund. So, as an employer, I’m going to want to treat you as an independent contractor so I can avoid all those extra taxes.
According to the IRS, an independent contractor is defined as follows:
“an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.
In other words, if you tell me that you want me to review your Quickbooks files and prepare financial statements that your bank requires, but I decide when I will do the work and whether I can work at home or your store, then I am an independent contractor. But if you hire me to enter sales and billing information into Quickbooks, and that I am to work from 10 a.m. to 2 p.m. at your office, then I am an employee.
The key to figuring out if you are an employee or an independent contractor is the degree of control and independence you have in doing the job. The IRS looks at three categories:
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Behavioral
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Does the company control or have the right to control what the worker does and how the worker does his or her job?
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Financial
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Are the business aspects of the worker’s job controlled by the employer (how the worker is paid, are expenses reimbursed, who provides tools and supplies, etc.)
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Benefits
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Are there benefits such as insurance or paid vacation? Is the work ongoing or is it a one time assignment?
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I use this Quick Guide for an easy-to-use reference chart for deciding my status. The IRS also has a reference that can give additional help.
It is best to clarify your status before you accept the job. If the person hiring you does not claim you as an employee and, therefore, does not withhold taxes and pay the employer portion of taxes, you will be liable for both the employer and employee portion of the taxes unless you can prove to the IRS that you were actually an employee.
Let’s say you have reviewed the rules and have decided that you are an independent contractor. How do you handle your taxes?
All self-employed people must make quarterly tax payments based on their estimated annual income. Estimated tax is how you pay social security and Medicare taxes and income tax, because you do not have an employer withholding these taxes for you. For 2012, these payments are due on April 17, June 15, September 17 and January 15, 2013. The IRS requires Form 1040-ES for filing estimated tax payments. The worksheet for figuring out the correct amount to pay can be a bit confusing, so as a general rule I withhold at least 35% of my income.