Steven Moore
Roles and Responsibilities (R&R): The Tax Implications of Temporary Employees vs. Contractors vs. Consultants
Good day readers. We continue our mini-series of articles that focuses on some of the different types of professionals that businesses work with. These workers are types of contingent professionals: temporary employees, contractors, and consultants.
In this article, we will evaluate the tax implications a business must consider for each of these professional types. We look at the potential tax collection and reporting impact of each professional type on a business.
Check out our lead article in this series here where we discuss each type of role in greater depth.
The Tax Implications of Contingent Professionals
Tax implications for temporary employees, contractors, and consultants differ significantly due to the nature of their employment status. Here's a breakdown of how taxes are handled for each:
Temporary Employees
Employee Status: Temporary employees are considered employees of either the company they work for or the staffing agency that placed them. This means they are classified as W-2 employees in the United States.
Payroll Taxes: The employer (or staffing agency) is responsible for withholding federal and state income taxes, Social Security, and Medicare taxes from the temporary employee’s paycheck. The employer also pays a portion of the Social Security and Medicare taxes, as well as unemployment taxes and possibly workers' compensation insurance.
Year-End Tax Forms: Temporary employees receive a W-2 form at the end of the year, which details their earnings and the taxes withheld. They use this form to file their personal income taxes.
Contractors
Independent Contractor Status: Contractors are considered self-employed, meaning they operate as independent businesses rather than employees. In the U.S., they are classified as 1099 workers, named after the IRS form used to report their income.
Self-Employment Taxes: Contractors are responsible for paying their own income taxes, including both the employee and employer portions of Social Security and Medicare taxes, known as self-employment taxes. This can amount to about 15.3% of their net earnings, in addition to federal and state income taxes.
Estimated Taxes: Contractors typically make quarterly estimated tax payments to cover their income tax and self-employment tax obligations. This helps them avoid penalties for underpayment at the end of the year.
Deductions: Contractors can deduct business-related expenses, such as office supplies, travel, and equipment, which can lower their taxable income.
Year-End Tax Forms: Contractors receive a 1099-NEC form from each client that paid them $600 or more during the tax year, summarizing their earnings. They use this information to file their taxes.
Consultants
Independent Consultant Status: Like contractors, consultants are typically self-employed and classified as independent contractors (1099 workers) for tax purposes.
Self-Employment Taxes: Consultants must pay self-employment taxes, covering both the employer and employee portions of Social Security and Medicare taxes, along with federal and state income taxes. They also need to make quarterly estimated tax payments.
Deductions: Consultants can deduct business-related expenses, which might include costs for research, professional development, marketing, travel, and any specialized tools or software they use. These deductions help reduce their taxable income.
Year-End Tax Forms: Consultants also receive a 1099-NEC form from each client that paid them $600 or more. They must report this income when filing their taxes and account for any deductions.
Overall Tax Considerations
Temporary Employees: Taxes are straightforward and handled through employer withholdings. They receive a W-2 form and generally have fewer tax responsibilities beyond filing their personal income taxes.
Contractors: Responsible for their own taxes, including self-employment taxes. They can deduct business expenses and must manage quarterly estimated tax payments. They receive 1099 forms for reporting income.
Consultants: Similar to contractors in tax responsibilities. They manage self-employment taxes, business deductions, and quarterly tax payments, and also receive 1099 forms for income reporting.
Bringing it all together
Taxation scope has significant impact on a company's decision between hiring permanent employees or partnering with a contingent-type of professional. Understanding the tax implications of this decision is crucial for both the workers and the companies that hire them, as misclassification can lead to significant tax penalties and legal issues. It is also important for working professionals in either of these types of roles to consider their own tax situation when either joining a company and also when preparing their tax returns, whether for state filing or for IRS filing.
As businesses navigate the best solution for their operational needs, the choice between temporary employees, contractors, and consultants requires serious thought and planning. Ultimately, it's important to note that the choice between either one or all of these solutions depends on the specific needs, size, and complexity of the organization, as well as budget considerations.