What are the tax implications of classifying a worker as an employee vs. an independent contractor?
Employees' gross wages are subject to federal income tax withholding, FICA taxes (social security and medicare), and any applicable state withholding and payroll taxes. In addition, the employer is responsible for paying FICA taxes (social security and medicare), FUTA, and any applicable state employment taxes.
The business does not have to withhold taxes or pay federal or state employment taxes on payments made to independent contractors. Additionally, the employer is not responsible for worker's compensation. The independent contractor is responsible for paying their own payroll/employment taxes.
At a minimum, for a worker that receives compensation below the current social security limit, the total worker expense is reduced by 8.45% (7.65% for FICA and 0.8% for FUTA) when a worker is classified as an independent contractor as opposed to an employee. This reduction is what drives employers to want to classify a worker as an independent contractor, however, the IRS resognizes the tax/expense reduction, which is what makes it a sensitive subject.