Independent contractors are not employees, they are workers typically compensated on a per-project basis, and the hiring employer is not responsible for withholding taxes from their pay. Independent Contractors are often referred to as freelance. They are their own boss and lend out their services.
Because employers don’t have to withhold taxes for independent contractors, it can be significantly cheaper to hire a freelancer rather than hire an actual employee.
But these tax restrictions make it vital for businesses to correctly classify their workers as either contractors or employees. Misclassification can lead to steep IRS fines and penalties.
For instance, if you hired an artist to make a business logo for you, they would be an independent contractor. They are independent because:
- They are not told how to do their job.
- They choose which hours they work.
- They choose where they work.
- They use their own tools.
These are not the only things that make an independent contractor, nor do you need all these. According the IRS, the general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done.
In California, if you hire an independent contractor, you must submit a Report of Independent Contractor (DE 542) to the Employment Development Department (EDD). Similar to how you had to report hiring a normal employee. You technically only need to report the hiring if you intend to pay the contractor over $600.
The purpose of reporting all these employees and contractors is so the state can let you know if you need to withhold additional money from their paycheck. Perhaps the contractor has a court-order to pay child support payments or is on some sort of restitution repayment plan. The contractor probably won’t tell the state money is being earned, so you have to.