Small Business Tax Tips

Using Independent Contractors to Avoid Payroll Taxes

Using independent contractors instead of hiring employees can reduce your payroll taxes. It's no surprise that many entrepreneurs are switching from full-time hires to part-time free agents who can still get the job done.

The hassle and expense of reporting payroll taxes can test the patience of any small business owner.

There has got to be a better way of doing business, right?

Maybe there is. If you haven't explored the possibility of farming out some (or even all) of your work to independent contractors you may be overlooking an opportunity to offload the burden of payroll tax reporting once and for all.

The availability of independent contractors as a staffing tool is common knowledge in small business circles. Many small business owners rely on independent contractors to meet project deadlines or for specialized tasks such as accounting or IT services.

Even so, the use of independent contractors still tends to be underrated in many small businesses, especially when you consider the significant payroll tax benefits involved.

Withholdings for Independent Contractors

In a traditional employee relationship, the employer is responsible for withholding taxes the employee owes to federal, state, and local governments, and remitting them to the proper agency. If you only have a few employees, this may not seem like such a big deal. But as your number of employees increases, it can become a major undertaking. However, independent contractors are responsible for withholding and remitting their own taxes, shifting the burden away from you and your office staff.

Payroll Taxes for Independent Contractors

As you know, employers are responsible for paying a portion of their employees' payroll taxes, specifically FICA and unemployment insurance withholdings. But if the worker is self-employed (like an independent contractor), the employer is no longer responsible for paying any portion of these taxes.

Legal Requirements for Independent Contractors

Although some laws may still apply to independent contractors, in many cases the use of non-employee labor frees you from the legal liability of statutes like minimum wage requirements, workers' compensation issues, and other restrictions.

Reporting

Although it will greatly reduce the amount of time you spend on recordkeeping and reporting, the use of independent contractors does not totally free you from reporting requirements. Traditional employees receive a W-2 form that reports their annual earnings and withholding at year-end, as well as other documentation relating to their employment in your company. Amounts paid to independent contractors, on the other hand, are reported on just one form - Form 1099.

Classification Requirements

The rising popularity of independent contractors as a staffing resource has prompted the IRS to come up with requirements to determine the legitimacy of workers classified as an independent contractor. Suffice it to say that the IRS does not look favorably upon employers who designate their entire staff as independent contractors to avoid tax and reporting requirements. The IRS criteria involves a checklist of twenty factors designed to separate independently employed workers from traditional employees. If you're not sure whether or not a worker meets the standards of an IRS independent contractor, download a copy of Form SS-8 from the IRS website at www.irs.gov.

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