If you are hiring a new employee, you must have that person fill out a W-4 form. If you are hiring an independent contractor, you must have that person complete a W-9 form.
Establishing the Correct Relationship
It is important to determine whether you are hiring an employee or an independent contractor because it determines whether you, as the employer, must withhold income taxes from their pay.
Employers must withhold income taxes from an employee’s paycheck but do not withhold taxes on payments to independent contractors. Independent contractors are subject to self-employment taxes and must pay those taxes themselves.
Common methods for determining an independent contractor
Independent contractors are not controlled by the paying company in the method of how the work is performed, they only control the end result of the work. For example, the paying company cannot dictate the instructions or tools used for a job.
Financial control refers to facts that show whether or not the business has the right to control the economic aspects of the worker’s job. Independent contractors are usually paid a flat fee for a job, unlike an employee, who receives a regular paycheck.
Independent contractors are also free to seek other jobs and usually do not work solely for one paying company and leave once the work is completed. Independent contractors usually invest a significant amount into purchasing and using their own tools when performing jobs for paying companies.
Type of Relationship
The type of relationship (employee or independent contractor) may be stated on a contract between the two parties prior to work being performed. Independent contractors usually do not receive the benefits that employees may receive from their employer such as insurance, retirement plans, or vacation pay. Independent contractors are also not expected to have a permanent relationship with the hiring company, the relationship between the two usually ends after the completion of the job.
The consequences of misclassifying workers can be quite significant in terms of taxes and fees.
Employers can be held liable for all income taxes of independent contractors that should have been classified as employees, as well as any penalties that have accrued. Employers may also have to pay back any other wages, workers’ compensation, or overtime owed to misclassified employees.
For more information about W-4 and W-9 forms, please refer to our previous articles “Stay in compliance with new employees with form W4 and form I9” and “Can I Get a W9?”