Should you hire an employee or engage a contractor for the task at hand? If you need freelancers to produce goods or services for your market, you pay their fees without deducting any taxes. To help you decide who should be an independent contractor, the IRS sets down guidelines that involve how and where they work. As with salaried workers, independents generate costs that you can deduct from your business income.
Employees and Independent Contractors
Many business owners must deal with the age-old hiring dilemma: W-2 or 1099, employee or independent contractor. According to IRS guidelines, an employee is someone the boss directly controls. The employer sets the time and place of work, the amount and type of work performed, and the use of tools or equipment. An independent contractor decides on a work schedule, is free to accept or reject assignments, and does not work on the business premises.
1099s and W-2s
Employees get a salary or hourly wages, employers withhold income and payroll taxes. At the end of the year, the employer kicks out a W-2 for tax purposes, declaring the amount of wages and withholding. For an independent contractor, the yearly tally arrives on a 1099-MISC, giving the amount of fees, commissions and other compensation. On a 1099, there are no deductions: an independent contractor pays his own income taxes as well as the self-employment taxes. The SE taxes go into the same trust fund as payroll taxes and pay for Social Security and Medicare.
An employer can deduct all costs associated with the business. This includes the wages or salary of employees, as well as fees paid to independent contractors. You would claim business deductions on Schedule C, the IRS form used to report business income. You deduct commissions and fees on Line 10, contract labor on Line 11, and wages on Line 26.
Other Deductible Costs
There's more than one way to declare business deductions. In addition to any fees you pay, you can also write off the cost of tools, equipment and training. The contractor, in turn, can deduct her own costs. That could mean transportation, materials, tools, Internet access fees and the cost of dedicated office space, whether or not the office is at home. The IRS allows only deductions that are "reasonable, ordinary and necessary," and may slap you with an audit if the deductions seem out of line.
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