Tax Tracks: Employee Vs Contractor

Your work experience and, more specifically your work type, counts when you're determining how to handle your tax responsibilities. Whether you're entering the workforce for the first time or you're nearing retirement, it's always a good idea to brush up on some basics when it comes to how taxes are (or are not) being withheld from your wages. You might just save yourself some serious money and time.

Your Employment Classification

When you're hired to perform work, you will fall into one of two categories: employee or contractor. As an employee, or subordinate to some type of supervisor, you would have completed a W4 upon being hired. This form enables your company to withhold the correct amount of taxes to be paid to Uncle Sam every time you receive a paycheck (remember checking 0, 1 or 2 for your withholding?). In this scenario, your employer is responsible for transacting the taxes due from your wages and shoulders the burden of compliance.

Alternatively, you may have been brought on as a contractor. If this is the case, you complete work for an individual or company, but not necessarily according to any direction; in other words, you get the work done on your own terms. As a contractor, your taxes are not withheld from your compensation. Instead, you are responsible for calculating and paying the correct amount in tax throughout the year.

Quarterly Vs Annual Filing

If you're an employee, you receive a W2 at the beginning of each year, typically before February. This W2 details your annual income, including how much was withheld for taxes. Using this statement, you can prepare and file your taxes (due April 15th). Depending on how much tax was withheld, along with any credits and deductions you may be eligible for, you determine how much you owe (or, if you paid too much in taxes, how much you will receive in the form of a tax refund).

Your responsibilities as a contractor, however, are diametrically opposed to those of your employed counterpart. Since you are responsible for withholding and paying taxes yourself, you're actually required to estimate and pay what you owe on a quarterly basis: January 15, April 15, June 15 & September 15. The good news is that as a contractor, itemizing your deductions can greatly reduce your tax liability. If you are a mechanic, for instance, you may be able to deduct expenses for tools, equipment, uniforms – even a workspace.

The Third Employment Classification to Avoid, Tax Trouble and Professional Assistance

No matter how you're compensated for your work, you're required to pay taxes. Some individuals offer under-the-table work, proposing that they omit reporting wages and, subsequently any tax liability, to the government. As tempting as this might sound, accepting such an offer is an invitation for trouble. Should the IRS discover your arrangement, both you and your employer can be held responsible for tax evasion – a criminal offense – not to mention back taxes, penalties and interest.

Similarly, choosing to simply opt out of paying taxes is ill-advised. While this is more likely as a contractor, the IRS has zero tolerance for individuals who fail to pay taxes by the due date(s). If you are a contractor, it's important to file and pay on time, each quarter. It's very easy to fall behind and wind up deep in tax debt. If this is the case, or you're facing some other type of IRS collection action, be sure to consult with a licensed tax professional. Regardless of how you're paid and taxed, correcting an IRS issue is far simpler with the help of a seasoned tax professional.

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