CONTRACTORS, PROFESSIONAL SERVICES

Independent Contractors Taxes

Many entrepreneurs work with independent contractors on a regular basis to complete projects. While contractors and employees may carry out similar tasks, a key distinction between an independent contractor and an employee is that an independent contractor has the right to control what, when and how work will be done. Generally, the only control you, the entrepreneur, has throughout the process is to dictate what the result of the work is. For many entrepreneurs, it is favorable to hire independent contractors since you are not required to pay employer payroll taxes on their earnings or provide other benefits that would normally be included as part of an employee's compensation package. Despite the tax benefits of hiring a contractor, you should carefully consider how the people you hire should be classified since choosing incorrectly could end up costing you.

PROFESSIONAL SERVICES

Many entrepreneurs work with independent contractors on a regular basis to complete projects. While contractors and employees may carry out similar tasks, a key distinction between an independent contractor and an employee is that an independent contractor has the right to control what, when and how work will be done. Generally, the only control you, the entrepreneur, has throughout the process is to dictate what the result of the work is. For many entrepreneurs, it is favorable to hire independent contractors since you are not required to pay employer payroll taxes on their earnings or provide other benefits that would normally be included as part of an employee's compensation package. Despite the tax benefits of hiring a contractor, you should carefully consider how the people you hire should be classified since choosing incorrectly could end up costing you.

LANDLORD

Dinesh is a landlord who owns multiple rental properties in proximity to a college campus. During the summer, he paid $750 to a professional cleaning service so his property would be ready for new tenants in August. The cleaning service brought their own supplies and completed the job in two days. When Dinesh prepares his Schedule E, he could deduct these costs on line 7.

DESIGNER

Frank is a sole proprietor website designer who often hires offshore development teams to help him build his websites. Frank dictates what features his websites must have and how the finished products should look and feel, however, the offshore development team is otherwise autonomous and self-sufficient. Since this arrangement would likely result in the development team being contractors, he would deduct amounts paid to his developers on line 11 of his Schedule C.

PHOTOGRAPHY

Darrell is an established freelance photographer who hires an intern each summer to help him with his photo shoots. Even though the nature of the working relationship is temporary, Darrell would likely need to classify his intern as an employee since he will likely have significant control over his intern, supply required equipment, etc. If instead Darrell hired another experienced freelance photographer to assist him, he may be able to deduct these costs as contract labor since this person presumably would be more autonomous and better equipped to complete the work independent of Darrell than an intern would be.

UBER DRIVER / RIDESHARE

Mike drives full time for Lyft and makes a point to take full advantage of all tax breaks available to him. Last year Mike paid a CPA who has her own office space and fifty other clients $450 to prepare the Schedule C for his driving business. While this accounting fee is paid to an independent contractor, it would be deductible on line 17 of Mike's Schedule C since it was a professional expense.

SEP RULES TO KEEP IN MIND

  • Generally a contractor will have the right to control how, when and where work is completed, they will furnish the tools required to complete a project, their services will be available to others, the nature of your working relationship with them will be temporary and you will not typically provide them with benefits. Note that these are just some of the criteria to consider. Refer to the IRS or your tax advisor for additional guidance and keep in mind that all factors should be considered when determining if the person you hire is an independent contractor or an employee.
  • When you hire a subcontractor, you should request they complete a W-9 so you have all the information you will need to issue them a 1099-MISC at the end of the year should you pay them over $600 for services.
  • Payments to independent contractors can be deducted on different lines of your Schedule C or your Schedule E depending on the nature of the work your contractor performs. For example, you would deduct amounts paid to your independent lawyer or accountant on line 17 of your Schedule C, while amounts paid to an offshore web developer for support on your business website would be deducted on line 11 of your Schedule C.
  • If you are unsure if you should consider the people working under you as employees or contractors you can complete Form SS-8 and the IRS will advise you on the appropriate classification. Note that if you misclassify an employee you can be held liable for employment taxes for that worker. If you misclassified a worker in the past, you may be able to seek partial relief from paying federal employment taxes for eligible taxpayers by participating in the Voluntary Classification Settlement Program.
  • As an entrepreneur, while the work you do for your clients or customers likely can be categorized as contract labor, you should consider if any of your working relationships look like you are an employee.

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