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Employee vs. Independent Contractor; Tax Benefits of Both

written by: wendyppp•edited by: Donna Cosmato•updated: 6/29/2011

There are a number of tax benefits to having employees and independent contractors. Read on to discover which will benefit your business more.

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    The IRS has several sets of rules concerning how taxes are assessed on the employee vs. independent contractor. These rules are very different. Some of the differences are as follows:

    First, employees have their taxes withheld from their pay each period to be paid in advance every quarter. This often leads to a tax refund at the end of each year as the withholding amount is usually more than the actual tax. Social Security taxes are held at a rate of 7.65% with the employer paying the same amount.

    Independent contractors are responsible for figuring their own taxes on a quarterly basis and sending them in to the IRS. Contractors are responsible for paying the full 15.3% social security tax. One huge difference in comparing employee vs. independent contractor taxation is that employee taxes are figured on gross wages while contractor taxes are figured on net pay after taking out the expenses associated with doing business.

    Employees are often given the advantage of filing their tax returns on shortened tax forms such the 1040A or 1040EZ, depending on their circumstances. Independent contractors are required to file the long form, 1040 in order to itemize every expense and tax deduction to which they are entitled. Failure to do so would inevitably result in contractors paying more tax than is really required. Therefore, when looking at the paperwork requirements of employee vs. independent contractor for tax purposes, the employee comes out ahead.

    The forms required to be sent to employees and contractors for filing their tax returns are slightly different as well. Employees receive a form W-2, which shows their gross earnings, taxes withheld, and any advance EIC payments or 401K contributions that would affect the amount of tax owed. Contractors receive a form 1099 that shows only the gross amount paid to the contractor. It is the responsibility of the contractor to document expenses that affect the amount of tax actually owed. Thus, the accounting practices of employee vs. independent contractor favor the employee in terms of ease.

    When comparing the differences for tax purposes of employee vs. independent contractor most of the tax advantages and lowered paperwork requirements favor the employee. The one way in which the contractor is favored is in the ability to deduct expenses associated with completing a job so that tax is only paid on the net amount of profit made as opposed to the gross wage paid to an employee.