How Does Your Payroll Service Handle Contractors?

Posted by on October 23, 2013 in Financial Services, Hiring [ 0 Comments ]

payroll servicesA few years ago the Government Accounting Office estimated one-third of U.S. workers were self-employed. However, that number is even larger now, considering the number of recent college graduates, the amount of people who’ve been laid off and those who are picking up short-term gigs while looking for full-time employment.

Chances are, if you own a small business, you might be tapping into this informal workforce at one point or another. And it’s critical for the financial well-being of your company that your payroll service knows how to handle contractors.

Classifying Contractors vs. Employees

The first step is to make sure that contract workers are properly identified. Business owners are required to withhold income taxes, withhold and pay Social Security and Medicare Taxes and pay unemployment taxes on employee wages, according to the IRS. Whereas with part-time employees, a business is not required to withhold or pay taxes for independent contractors.

Related: Tex Returns for the Self-Employed

What distinguishes a contractor from an employee is the level of control the business has over the person. To determine whether someone is a contractor, ask the following questions:

  • Will the work be performed on the premises of your business?
  • Is the individual only working for you?
  • Do you provide the tools necessary for the individual to do the job?
  • Is the individual compensated for business-related expenses?
  • Do you control the hours the individual works?
  • Does the company control what the individual does and how the individual does his job?
  • Does the individual receive benefits from the company (ie: a pension plan, paid vacation, insurance, etc.)

If you answered “yes” to these questions, the individual should most likely be classified as an employee. However, if you are still unclear, you can file a form SS-8 (Determination of Worker Status for Purposes of Federal Employment Tax and Income Tax Withholding).

Related: Get Competing Quotes on Payroll Services Now.

It is extremely important that you correctly identify those working for you. You might be held liable for employment taxes on any worker who was misclassified as an independent contractor. In addition, workers who believe they were improperly classified can file a form with the IRS to to figure and report their share of uncollected Social Security and Medicare taxes due on their compensation.

New independent contractors should receive a form W-9 to fill out. And, as of 2011, if you paid more than $600 to a contractor in a year, you must complete and give them a form 1099-MISC by Jan. 31.

Paying Your Independent Contractors

Contractors are generally paid by project or by commission (although professionals like attorneys and psychiatrists might be paid hourly). Experts advise avoiding paying contractors through the same payroll system you use to pay employees, as it can lead to tax and record-keeping problems. One alternative is to pay them through accounts payable.

Related: Payroll Services: How Much Should You Outsource?

Questions To Ask Your Payroll Service

If you outsource your payroll services, be sure to ask the vendor these questions about how they handle independent contractors:

  • Can you act as the employer of record or the agency of record?
  • Can you help with classifying independent contractors vs. employees?
  • Do you take care of filling out and filing Form 1099-MISC?
  • Are independent contractors billed through a separate financial service or through payroll, the same as all your other employees?
  • How do you handle invoices?
  • Do you offer contract-writing services?
  • What services do you provide in the case of an audit?

As more and more companies end up using contractors in place of full-time employees, it’s extremely important to be paying them properly. The consequences of not doing so can be costly.

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