Starting a New Job as an Independent Contractor
By William Perez. Tax Planning: U.S. Expert
William Perez has worked as a tax professional since 2004. He earned the enrolled agent designation by passing a comprehensive examination on federal taxes and maintains his credential by taking continuing education classes.
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Sometimes this is legitimate, but sometimes this is a move on the part of companies to avoid paying payroll taxes at the expense of their workers.
A comment left on the post "What's Form W-9? " caught my attention in this regard. The question deserves a fuller response, and you might have some advice to add yourself .
The question asked was this:
"Hi, I am a fresh grad with no idea about this income tax thing. I joined a website [. ] where people hire you online. My problem is the site is asking me to submit a W9 form and I don't know what it is for. I have never been employed and I don't have any ideas what will happen if I pass that form. Will I be doing income tax returns when I submit that form? Will I be he one to compute my income tax? Sorry for being stupid but I really need help."
The reader's question is reasonable, not at all stupid. In fact, with such a wide variety of tax forms, it is often a chore just to figure out what a particular form means and how the information will be used.
Form W-9 is used by a company to request the name, address, and Social Security number for an independent contractor who will be providing services to the company. Another term for an independent contractor would be consultant or freelancer. There's a distinction made between independent contractors and employees.
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They are treated differently in how their income is taxed and reported to the IRS.
For example, if I hire a Web designer to redesign my site, I would ask them to fill out a W-9. I would then use that information, first, to verify their name and address; and second, to issue them tax form 1099-MISC at the end of the year. Form 1099-MISC is used to report money paid to contractors for their services. This form is send to both the IRS and to the contractor.
Now there's a couple of issues I can foresee that this reader might want to take into consideration. First, is whether he thinks the company is reputable and he will definitely be working for them. The reason I mention this, is that I have grave misgivings over how frequently our Social Security numbers are given out and now floating around in various files, databases, and hard drives by various companies. Like all tax forms, the information on a W-9 must
be kept private, secure and confidential. Any person or company that discloses tax information without the person's permission can face severe penalties. In this sense, it is better to safeguard any SSNs and other tax information.
On the other hand, the company is required to obtain your legal name and SSN using Form W-9 if the independent contractor will be earning more than $600 from the company during the year.
I do have a second concern, and that's whether this reader is an independent contractor or an employee. The difference impacts how income is reported and what tax rates apply. Independent contractors act as consultants or outside experts who usually work on a specific project for a company. Employees, on the other hand, are hired to work for the company and the company provides extensive tools, resources, and training for employees to do their job. The difference between the two involves the degree of control exercised over the worker.
For tax purposes, employees receive wages which are subject to income tax and various payroll taxes for Social Security, Medicare, and various state and local taxes. Independent contractors are also subject to the income tax and to the self-employment tax. which covers Social Security and Medicare. There's two big differences here. One is that employees are taxed on the full amount of their wages, whereas independent contractors are taxed only on their net profits (after business expenses are deducted). This could result in a lower tax liability for independent contractors. On the other hand, companies are required to pay half the payroll taxes for Social Security and Medicare for employees. Independent contractors are required to pay both the employees and employers share of these taxes, and the client would not have to be responsible for any of these taxes. Companies that are looking to keep their overall expenses low often prefer to hire contractors so the company won't have to be on the hook for payroll taxes. Workers who do not have to pay for a lot of out of pocket expenses, however, fare better as employees since the company pays half of these payroll taxes.
Finally, there are different types of recordkeeping and planning you will want to do. As an employee, there's not much to keep track of. The employer will send employees a Form W-2 at the end of the year which shows how much wages were paid and how much was deducted for taxes. Independent contractors, however, need to keep track of income as they earn it, along with any expenses related to their job, and may need to pay taxes in advance through quarterly estimated taxes. As a contractor, it is usually advantageous to be working with an experienced tax professional who can help set up a record keeping system and provide advice and strategies.Source: taxes.about.com