Jun 7, 2023
4 min read

A company guide to employee and independent contractor taxes

employee taxes guide and spend management time savers
Quick summary

Tax implications for employers differ when working with employees and independent contractors. Understanding the tax differences is essential to ensure your company files the proper tax forms and remits correct tax payments.

Table of Contents

    The biggest difference between an employee and independent contractor is the treatment of Social Security and Medicare taxes (collectively referred to as FICA taxes), and income taxes. An employee has FICA taxes deducted from each paycheck, which the employer holds to remit to the government. The employer then matches the FICA deduction when making payment to the government. For example, suppose an employee owes $500 in FICA taxes during each pay period. The employer withholds $250 from the paycheck and covers the remaining $250 for the employee. The employer then remits this amount to the government. Federal and state income taxes are also withheld from an employee’s paycheck.

    It is the employer company’s responsibility to hold employee tax withholdings in trust for monthly payment to the proper tax agency. A review of the amount of withholdings as part of the month-end closing process is an effective way to ensure accuracy and completeness of company tax filings.

    Improve spend visibility & control with Payhawk corporate cards

    Independent contractor taxes

    Independent contractor taxes are much simpler from the employer company’s point of view. Independent contractors do not have FICA, state, or federal income taxes withheld from payments received. Independent contractors are considered self-employed, and it is their responsibility to calculate the correct self-employment tax amounts and remit to the appropriate tax agency.

    For employers, hiring an independent contractor relieves the company of having to withhold any taxes from the contractor’s paycheck. At year end the employer will submit a 1099 form to the IRS to report the contractor’s earnings for the year and deliver a copy to the contractor for tax filing purposes.

    Tax form differences

    Employees receive a W-2 form from their employer by January 31 of the following year to file taxes on wages earned the previous year. The form states wages earned, withholding amounts, retirement contributions, and additional information relevant to the employee’s tax filing. It is important for employers to send these forms in a timely manner as it is needed for employees to calculate their yearly taxes.

    Clients of an independent contractor provide a W-9 form that the independent contractor completes. The employer then provides a 1099-MISC form to the independent contractor with earnings details.

    Independent contractors are also required to file quarterly Form 941 to report their FICA tax withholdings.

    Employer tax deadlines

    At quarter end, businesses that have employees must file proper federal and state tax forms and send tax payments to the appropriate tax agency. Below are the important tax deadlines companies must meet to ensure compliance with tax authorities.

    • April 15 – Taxes calculated from January to March
    • June 15 – Taxes calculated from April and May
    • Sept 15 – Taxes calculated from June to August
    • Jan. 15 – Taxes calculated from September to December of prior year

    Common mistakes to avoid

    Misclassification

    One of the biggest issues companies encounter is misclassification of an employee as an independent contractor as this can have substantial tax consequences.

    Companies do not need to withhold and match tax withholdings from independent contractors, so some businesses believe that by calling an actual employee an independent contractor, they can save money on employer taxes. This is a big mistake for two reasons. First, proper tax forms such as the W-2 form will not be generated and filed, causing the company to not comply with tax laws.

    Second, the IRS will periodically check whether a business’s employees have been classified as independent contractors to avoid employer taxes. If the IRS does find this situation has occurred, they will not only require the company to pay all the back taxes owed, but also levy substantial penalties for attempted tax avoidance. In many situations these penalties have caused companies to declare bankruptcy or close altogether.

    Cash payments

    Another issue worth discussing is the tax treatment of cash payments. The IRS states that all income, however received, is taxable. Independent contractors often receive cash payments for services rendered. From an employer’s perspective, the situation calls for good record keeping and documentation to ensure all payments to independent contractors are correctly reported. Errors in recording these transactions can cause a higher tax bill, as payments to independent contractors for business purposes are tax deductible.

    Documentation

    The foundation of a company’s financial health is its accounting and bookkeeping department. Businesses should take extra care when recording tax-related transactions. This should entail having backups of all transactions entered into accounting software, such as an Excel backup to QuickBooks Online transactions.

    Having necessary backup documentation not only ensures that any questions from the relevant tax authorities are answered quickly, but also serves as a check that no transactions are duplicated or missing.

    How can Payhawk help

    Real-time reconciliation of business spend (not payroll)
    Reconciliations are notoriously difficult for most businesses, as they need to capture data easily and seamlessly sync this data with their ERP or accounting software. Payhawk’s clever OCR technology captures all relevant data and seamlessly integrates with your company’s software to update transaction data in real time.

    Tracking and reimbursing mileage
    Tracking business mileage expenses and reimbursements is also notoriously difficult. Payhawk makes this process simple. Simply enter in the mileage reimbursement rate and Payhawk’s custom journey tracking software will automatically calculate the correct reimbursement amount. Reimbursements can be made in a matter of clicks, in bulk or individually.

    Receipt chasing
    Employees or contractors not remembering to add receipts? No need to stress about that, at Payhawk, we send reminders until they upload the correct documents.

    Managing taxes is a considerable task which requires expert knowledge and attention. Make sure you have time to focus on filing and compiling all the right information. Remove your expense management administration burdens, get real-time reconciliations, and control company spend with innovative business credit cards from Payhawk. Book a demo to find out more.

    Legal disclaimer:

    The information provided in this article does not, and is not intended to, constitute legal, financial and/or tax advice. Instead, all information and content available herein is for general informational purposes only. The information presented herein may not reflect the most current legal developments. Readers of this article should consult with a qualified expert to obtain advice with respect to any particular legal, financial and/or tax matter. No reader of this article should act or refrain from acting on the basis of information contained herein without first seeking legal, financial and/or tax advice from an appropriate counsel in the relevant jurisdiction. Payhawk disclaims all liability in respect to actions taken or not taken based on any or all of the contents of this article to the fullest extent permitted by law.

    Trish Toovey - Content Director at Payhawk - The financial system of tomorrow
    Trish Toovey
    Senior Content Manager
    LinkedIn

    Trish Toovey works across the UK and US markets to craft content at Payhawk. Covering anything from ad copy to video scripting, Trish leans on a super varied background in copy and content creation for the finance, fashion, and travel industries.

    See all articles by Trish →
    Apr 25, 2024

    Loading...

    Apr 25, 2024

    Loading...

    Apr 25, 2024

    Loading...