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If you’re considering hiring workers for a home improvement project, you may be wondering what is a 1099 contractor, and the difference between them and a full-time employee. This blog will help you understand this class of workers in detail.
Even if you use a payroll agency to handle the hiring and paying of workers, it’s necessary to have a basic understanding of how to classify them. The exact status of the worker – whether they are W-2 employees or independent contractors – impacts the taxes for both of you.
So, what is a 1099 contractor? Well, a 1099 contractor is someone who works independently rather than for an employer. These independent contractors have significant differences in terms of legalities, taxes, and payments vis-à-vis an employee. This is despite the fact that the nature of work of both an employee and contractor is similar.
What is the difference between a contractor and an employee?
Employees get benefits such as healthcare and the stability of a full-time job. But, they will not have much control over the type of work they do.
An independent contractor, on the other hand, is not entitled to any benefits from an employer. However, they do get more benefits when it comes to taxes. Since they use their personal tools and building materials, they can deduct those expenses from their taxes every year.
Generally, 1099 contractors pay a self-employment tax on earnings of $400 or more. Of course, the exact tax amount will depend on specific situations. A legal or tax professional will be able to give a good idea about how 1099 contractors pay taxes.
What’s the difference between form 1099 and form W-2?
These tax forms are for different types of workers. A 1099 form is for independent contractors while a W-2 form is for employees.
All payroll taxes are automatically withdrawn from W-2 employees’ paychecks and remitted to the government by the employer. But, the contractor has to pay their own payroll taxes and file them quarterly with the government.
1099 contractors complete tasks on individual projects while W-2 employees are directed by the employers as to how, when, and where to work. So basically, an independent contractor – often called a consultant, entrepreneur, business owner, freelancer, or a self-employed individual – earns a living on their own rather than depend on an employer. As they do not belong to any particular company, they can simultaneously work for different clients at any given time.
How to distinguish between a contractor and an employee?
To evaluate whether a worker is a contractor or an employee, the Internal Revenue Service (IRS) has devised a set of criteria. The independent contractor is not regarded as an employee, but rather as a separate business.
An independent contractor:
- Follows his or her own work schedule. May turn down unattractive offers.
- Finishes assignments based on individual methods – on a case-by-case basis.
- Uses personal equipment, construction materials, and tools.
- May work with multiple clients at a time.
- Can be let go at any time if found unsatisfactory or unreliable.
- Earns a profit or incurs a loss without being answerable to anyone.
- Gets paid on a per-job basis.
- Charges an amount that compensates for their labor, time, and expertise.
- Pays for their business expenses as well as travel expenses.
- May hire subcontractors.
- Has to follow a set schedule of working hours.
- Receives training from the employer.
- Uses the company’s tools and materials.
- Gets work assigned by a single employer.
- Gets employee benefits and insurance coverage.
How does IRS decide if an individual is a contractor or an employee?
The IRS has set three general criteria to identify contractor vs. employee.
Behavioral control: If an individual is directed and trained by an employer regarding the working hours, how to utilize the tools, and the way to complete a job – he or she is an employee.
If a worker sets his or her own working hours and doesn’t take direction or training from anyone, he or she is an independent contractor.
Financial control: One needs to look at how the worker is paid for a job – is the payment made to a company or directly to the individual. Also, whether the worker in question is free to work for other people at the same time. A full-time employee doesn’t have that choice.
Type of relationship: One needs to look for a specific contract to know if the worker is an independent contractor or an employee entitled to benefits.
Does a contractor pay income tax?
An independent contractor, like anyone else who works, must pay income tax in the United States. However, contractors do enjoy some excellent tax breaks. For example, they do not have Social Security and Medicare taxes deducted from their salary.
Independent contractors or single-member limited liability firms (LLCs) must disclose all income, costs, profits, and losses on Schedule C of Form 1040 or Schedule E. They must also file self-employment taxes with the IRS on Form 1040-ES, which must be done at least once a quarter. Furthermore, independent contractors cannot wait until April 15 to pay all of their prior year’s taxes. Instead, they have to pay the estimated taxes on a quarterly basis.
Do 1099 contractors need a written agreement for work?
Any contractor needs to ensure that they are paid for a job they take on. If a client does not pay after being invoiced, the contractor can take legal action to pursue the payment.
That’s why it’s imperative that the contractor has a written agreement before starting any real estate construction or repair work for a client. It will help them avoid any legal disputes later or during the renovation work. The written contract should clearly state the service description, the expected timeline, how much the contractor will be paid for his or her work, and the payment schedule.
Advantages to being a 1099 contractor
The advantages of self-employment include:
- Not being answerable to an employer; being your own boss.
- Having the potential to be paid more than regular employees.
- No withholding of federal or state tax from pay.
- Ability to take many small business deductions on the taxes.
Disadvantages of being a 1099 contractor
The disadvantages of being a self-employed individual include:
- There’s no job security.
- Paying self-employment tax on their own.
- Personal liability for business debt.
- Zero employer-provided benefits.
- No unemployment insurance benefits.
- No workers’ compensation coverage.
- Fewer protections from labor laws as compared to full-time workers.
What is an employer’s tax liability?
When a person works for someone else, he or she is responsible for paying all state and federal unemployment taxes. The employee is also accountable for contributing to a state insurance fund by paying Social Security tax, workers’ compensation premiums, and disability premiums.
That’s why it’s important for the hiring company to properly classify their workers. They may end up being liable for any unpaid taxes, including federal unemployment tax and FICA if the worker in question is an employee who has failed to pay the dues.
Things to check before hiring an independent contractor
If you’re hiring a 1099 contractor, you need to perform a background check to review the person’s commercial, financial, and criminal records. In the case of hiring licensed employees, the background check is the responsibility of the employer.
They ought to know the job history, work experience, degrees, specialization, and benefits enjoyed by the employee.
How to pay a 1099 contractor?
When it comes to paying an independent contractor, the payment process is generally outlined in the independent contractor agreement. While some contractors choose payment on an hourly basis, others prefer payment by the job.
Once the job is complete within the agreed time frame and reflects the expected quality of work, the contractor is paid.
Now you know who or what is a 1099 contractor. Simply put, such an individual is paid for the work they do, with no benefits or tax deductions. Independent contractors, freelancers, self-employed individuals, and sole proprietors are all terms used to describe them.
- These self-employed contractors are not eligible for employee benefits but enjoy certain freedom that a standard employed worker doesn’t.
- Since there’s no income tax withholding, they must pay the estimated income tax in advance through quarterly payments.
- They can reduce their gross income through business deductions. This helps lower their tax bills.
- Such independent contractors have to arrange their own health insurance and retirement plans.