Key U.S. Tax Compliance Queries for Enterprises Employing Remote Contractors
For all the benefits that come with hiring remote contractors, enterprises can also find themselves in a sticky situation if even one contractor can fall into the employee category. To avoid costly penalties, get familar with the most popular tax compliance queries below.
Rivka Abramson| Dec 10, 2023
- As your enterprise expands, it becomes more and more challenging to remain compliant with U.S. contractor tax requirements.
- Whether inadvertently or purposely, treating contractors as employees can result in audits from the IRS.
- Understanding and abiding by IRS guidelines (eg. which documents and tax forms to submit) for remote contractors will prevent misclassification.
As an enterprise, you may already use remote contractors to advance your goals. While these workers are important for your business, it’s often easy for them to get lost in the shuffle and for managers to treat them as employees. For tax purposes, this mistake is costly.
The IRS may impose fines or penalties that can lead to a pause in operations or reputation damage. If your enterprise employs remote contractors, you’ll want to ensure you know the answers to the below common queries about compliance.
What tax forms do you need to fill in to make sure your enterprise is compliant to the IRS?
There are several tax forms you will need to complete to stay compliant. These include:
- Form W-9: U.S.-based contractors fill out the W-9 with their personal information such as their SSN/TIN. They’ll then send the form to their clients who use the information to report the correct income and taxes.
- Forms W-8BEN and W-8BEN-E: International contractors fill out the W-8BEN to prove they are a foreign business owner for tax purposes. Foreign entities must fill out the W-8BEN-E for tax withholding and reporting.
- Form 1099-NEC: Businesses use this form to report payments of $600 or more made to independent contractors living in the U.S. or abroad.
- Form 1042-S: Your enterprise can use the 1042-S to report amounts paid to foreign individuals including figures that were withheld and then repaid to the payee. You must use form 1042-S even if an amount has not been deducted from the payment due to a treaty or taxation exception.
What penalties can enterprises face for incorrect classification of independent contractors in IRS filings?
In instances of misclassification, you could face fines, penalties, back taxes and back benefits, and legal issues, such as lawsuits from those harmed by the misclassification. A few examples include: up to 3% of the misclassified employee’s wages, up to 40% of the FICA taxes the company did not withhold, payment penalties of up $1,000 per misclassified employee, and more.
What should an enterprise know about tax withholding and regulations for international contractors?
There are two situations enterprises should know concerning tax withholding for international contractors:
- When a foreign independent contractor works for a U.S. company but completes their work outside of the U.S., the company does not need to withhold or report taxes.
- If an international contractor performs any aspect of their work inside the U.S. the contractor must be classified as a non-resident alien, foreign corporation, foreign trust, and more to avoid tax obligation.
An exception to situation #2 is if the U.S. has a tax treaty for withholding tax rates with the contractor’s country of residence. Under these treaties, residents of foreign countries may be eligible to get taxed at a reduced rate or exempt from U.S. income taxes on funds they receive from companies operating within the United States. These reduced rates and exemptions vary among countries and specific items of income, so it’s best to look at each contractor’s situation before calculating taxes.
How often do enterprises need to report payments to independent contractors to the IRS?
Enterprises need to report payments made to contractors once a year. To report payments made during the fiscal year, you can fill out form 1099-NEC. The 1099-NEC tells the IRS how much money you paid contractors. You will need to file the form by February 28th (or March 31st if filing electronically).
Does the IRS provide guidelines for enterprises on classifying independent contractors?
The IRS does not provide any guidelines for enterprises when it comes to classifying independent contractors. Your business must follow all worker classification rules for other employers.
Can the IRS reclassify an independent contractor as an employee, impacting enterprise tax liabilities?
If the employer requests the IRS classify their worker, they will not receive a penalty. You can request the IRS classification by filling out and sending Form SS-8 to the IRS. If the IRS reclassifies an independent contractor as an employee, you will face full-rate tax exposure for these payroll taxes, totalling about 35% of the amounts paid to the independent contractor over the past three years.
What documentation does an enterprise need for IRS audits regarding independent contractors?
If the IRS audits your business, you will need to send copies of certain documents that support the income, credits, or deductions you claimed on your return. It’s important to note that all businesses must send copies of documents to the IRS, not the originals. Documents include:
- Invoice receipts- After receiving payment, some contractors opt to send a receipt detailing what the payment was for and the dollar amount.
- Independent contractor agreements- This lays out the terms of your working relationship and proves that the worker is an independent contractor.
- Professional licenses- These can promote the contractor’s independence.
- A link to the independent contractor’s website- This indicates that the professional was correctly classified.
- The contractor’s advertisements- Private advertising can help the IRS determine the correct classification.
- The W-9- this form collects the contractor’s personal information including their Taxpayer Identification Number (TIN).
How do enterprises maintain payment records for independent contractors for IRS tax purposes?
Payment records should include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. It is important to keep these documents because they support your tax return and internal books. Enterprises may want to store these documents in one place to stay organized.
A complete payroll software will safely store all records in addition to accommodating different payment methods so contractors get paid quickly and accurately. The most competitive payroll solutions also offer comprehensive reporting so organizations can see how much they’ve paid contractors in past years.
How does the IRS handle disputes with enterprises regarding independent contractor status?
If the IRS suspects misclassification, they will review the facts and circumstances to officially determine the worker’s status. If your business classifies an employee as an independent contractor and the IRS disputes the classification, you may be liable for employment taxes for that worker.
When your enterprise can provide a reasonable basis for treating a worker (not an employee) as an independent contractor, the business will not need to pay employment taxes for that worker. To get this relief, file all required federal information returns that support your treatment of the worker.
Lastly, any enterprise can enter into the Voluntary Classification Settlement Program (VCSP) which can help reclassify workers as employees for future tax periods with partial relief from federal employment taxes. To participate in this program, you must meet certain eligibility requirements.
Why are there different tax implications for enterprises using independent contractors versus employees?
Enterprises employ hundreds if not thousands of employees, typically a mixture of contractors and employees. When hiring both types of workers in large amounts, compliance is more complicated and requires distinct approaches.
Enterprises must ensure all global employees receive the benefits and tax withholdings according to the laws of their home country. Compliance laws also state that all employees must have the resources and tools needed for the job.
Contractor compliance requires enterprises to fill out specific tax forms and follow IRS common law rules for treating contractors.
Do enterprises need to withhold taxes for independent contractors as they do for employees?
Generally, enterprises do not need to withhold or pay any taxes on payments to independent contractors, with one exception known as backup withholding. Backup withholding is a tax deduction for when independent contractors provide the wrong TIN or incorrectly report their income on a tax return. In this situation, you may be required to withhold a percentage of any future payments for the contractor and deposit them directly with the IRS.
Can enterprises deduct expenses related to independent contractors on IRS tax forms?
No, enterprises can not deduct expenses related to independent contractors, as they are not employees. Independent contractors are responsible for providing any necessary tools or equipment to complete the job. They can, however, write off these business expenses.
How can enterprises ensure compliance with IRS guidelines for independent contractor agreements?
When creating independent contractor agreements that abide by IRS guidelines, include the following categories:
- Behavioural: This section will specify that your enterprise does not have control over what the worker does and how the worker does their job.
- Financial: You must lay out how you will pay the contractor, if you will reimburse expenses, who provides tools/supplies, and so on.
- Type of Relationship: The contract must state that your enterprise will not provide employee benefits (i.e. pension plan, insurance, vacation pay, and more) and that the relationship is not permanent.
Does the IRS offer consultation or guidance for enterprises uncertain about their responsibilities with independent contractors?
If you’re uncertain about a worker’s employment status, the IRS will provide a consultation. You can send in Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, and the IRS will send you and the worker a determination letter.
What are the potential financial impacts on an enterprise if an independent contractor is misclassified?
If your enterprise misclassified contractors, you may need to pay up to 3% of the misclassified employees wages, all of the FICA taxes that weren’t paid for the employee, and up to 40% of the FICA taxes that were not withheld from the employee’s wages.
What are the common payment terms for contractors?
Contractor payment terms typically outline how contractors expect clients to pay them. This includes:
- How a contractor charges for their work (i.e. hourly rates, pricing by deliverables, fixed costs per project, and more)
- The currency (they make take into consideration currency conversion rates)
- The payment method (i.e. wire transfer, check, direct deposit, and so on)
- The payment schedule (when the contractor will receive payment)
Can an independent contractor be paid a salary?
Independent contractors cannot be paid a salary. Workers who receive a regularly paid wage are likely considered employees, not independent contractors.
Make compliance easy with contractor management platforms
As your enterprise continues to grow, it becomes more and more challenging to comply with U.S. contractor tax requirements. This is where Papaya comes in. Our Automated Onboarding System allows you to hire and onboard in 160+ countries without entity establishment, provides country-specific onboarding workflows, and ensures compliance with local labor laws.
Papaya’s end-to-end payroll consolidation allows you to smoothly manage your entire workforce (payrolled employees, EOR, contractors, and more) while running various payroll cycle types (weekly, bi-weekly, or monthly payments) on time and according to local laws.
Finally, the Employee Portal helps contractors upload tax invoices and other supporting documents to protect your business from IRS inquiries.
For seamless and compliant contractor hiring and onboarding, leave the details to Papaya Global, while you run the bigger picture. Try a demo today.