Businesses that outsource some of their functions are required to use specific forms when filing taxes for independent contractors. "Independent contractor" is the term used by the Internal Revenue Service to designate a type of worker who contracts his or her services to a business.
First, be sure you're using the correct tax form when filing taxes for your actual employees. The W-2 form— an earned income statement that includes an employee's total income (wages, tips and/or commissions)—details the specific amount of federal, state and social security taxes withheld from the employee's paycheck. Employees must receive this form from their employer by January 31 of the year following payment, while employers have until February 28 (if you file electronically, the deadline is March 31) to file the W-2 form with the IRS. Penalties can be incurred if the employer fails to meet these deadlines.
You can learn more about the differences between an employee and an independent contractor here.
Tax forms for the independent contractor
Upon determining the status of the person receiving payment as an independent contractor, your first step is to request that the contractor fill out Form W-9, Request for Taxpayer Identification Number and Certification. The contractor must provide his or her correct name and a Taxpayer Identification Number (TIN). For the purposes of the IRS, a TIN can be the contractor's social security number or an employer identification number.
The IRS advises employers to keep each independent contractor's Form W-9 on file for four years in the event that any questions arise from either the contractor or the IRS.
The primary form to file for accurate tax payments to contractors is Form 1099-MISC. The threshold for reporting taxable compensation is payment of $600 or more to the independent contractor for services provided during a year. (Any amount under $600 does not have to be reported.) The deadline for filing Form 1099-MISC with the IRS is February 28 (if you file electronically, the deadline is March 31). In addition, the employer is required to provide a copy of the same form to the independent contractor by January 31 of the year following payment.
Independent contractors are obliged to pay their own income tax and self-employment tax to the IRS. However, businesses should be aware that if contractors fail to pay their state or federal taxes, the IRS can mandate employers to pay all withholding taxes, plus interest.
State requirements for independent contractors
It's important as well to pay attention to various state requirements regarding payment to independent contractors. In California, for example, if a business files Form 1099-MISC, it must also report independent contractor information to the Employment Development Department (EDD). Such information includes (but is not limited to):
- Taxpayer identification number
- Employer account number (if applicable in California)
- Independent contractor's full name and social security number
- The start date of contract (or date when payments of $600 or more were paid)
- The exact amount of payment
- Date when contact expires
The EDD uses this information when seeking to locate parents who have fallen behind in their child support obligations.
Other states have similar independent contractor reporting requirements. Contact your state government for more information.
While independent contractors can be a valuable resource for small businesses, particularly for time-limited projects and other special assignments, businesses must be sure to maintain proper record-keeping and make accurate tax payments in compliance with IRS requirements and regulations.