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Introduction to Payroll Accounting: Employees vs Independent Contractors



Two of our most requested services also happen to be two of our specialties here at ALP, The Firm. They are payroll and accounting. Today, I would like to briefly share with you some vital information that you need in order to understand a little bit about payroll accounting, and how your hiring decisions affect it. Whether you’re a startup online store or a Fortune 500 company, if your business has employees you must account for them in payroll. Today we’ll briefly discuss the differences between employees and independent contractors in relation to wages and taxes and how it affects your accounting.


In a previous blog, I explained the various types of financial statements companies must prepare, if you missed that one you can click here to read it. If your statements are prepared using the accrual basis of accounting, you must report all wages earned by your employees including salaries, commissions, and bonuses.


There are some significant differences when it comes to payroll accounting for your W2 employees versus Independent Contractors, but regardless of how your workers are classified, your company must report to the IRS the amount of money paid to employees or contractors. This is especially important because as your company is responsible for paying taxes on money it takes in, failure to have proper documentation and reporting could result in you paying thousands of dollars in taxes unnecessarily. For example, if in the course of a year your company receives $100,000.00 in payments, but you paid 25,000.00 out to Independent Contractors, your tax responsibility will only be calculated on $75,000.00. Those Independent Contractors will be responsible for paying taxes on the $25,000.00 they received. One thing that’s for certain is that Uncle Sam is going to get his money, so there’s no need for you to give him extra.


Another significant different between employees and independent contractors when it comes to benefits and deductions. Contractors do not receive any benefits and do not have any deductions for taxes, social security, medicare, or voluntary deductions deducted from their pay. Additionally, your company is required to have a W9 on file for them.


On the other hand, when you have employees, you are responsible for remitting payroll withholdings and employer-paid payroll taxes which vary based on the amount your employees are paid. Additionally, this involved the withholding of social security taxes, medicare taxes, income taxes, and other voluntary deductions that the employee may opt-in for. You also are responsible for filing a number of additional IRS forms including W-2, Form 941, and Form 940.


Depending on your business structure and your goals for your business will determine which hiring method works best for you. Many companies even have a combination of both. Our team would love to speak with you and help you determine which strategy works best for you and your business. For more information, please click here to schedule a call with one of our specialists today.

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