The trend in many companies is to not pay contractors directly as sole proprietorships (1099) or incorporated contractors but instead to require 3rd party billing. Sometimes, the client requires that the contractor be paid through a 3rd party as a temporary contract employee on a W-2 tax status.
The 3rd party will act as either the Employer of Record (W-2) or as the Agency of Record (Sole proprietorship/1099 or Incorporated).
What do you do when you are told that the contract requires 3rd party billing?
Obviously, we suggest calling or e-mailing Chancellor & Chancellor, Inc.
To help you understand the background for this request, we have described each tax classification below and the risk to the company if they were to pay you directly as a contractor.
Sole Proprietorship (1099).
This classification often puts the company at risk of a tax audit because the Internal Revenue Service may challenge the 1099’s validity and reclassify the contractor as a company employee. This could be very costly for the company. To ensure that you have independent contractor status (1099) rather than employee status, many companies now use a compliance test based on the IRS 20 questions. To limit companies’ liability, there may be insurance requirements. Companies generally prefer that a 3rd party be in place between themselves and the independent contractor.
Many independent contractors choose to incorporate because this limits their company’s risk of having a tax audit. In some cases the company may allow a direct vendor relationship (corporation to corporation).
There are several reasons why a company may still wish the incorporated contractor to pass through a 3rd party. It:
• reduces exposure to tax audits by eliminating red flags for the IRS
• gives tax compliance coverage
• meets insurance requirements
• provides single invoicing for multiple contractors
Temporary Contract Employee
The most common form of contract today. The contractor is an employee of an agency or payrolling firm. Taxes are withheld and an hourly salary is paid on a regular basis according to State and Federal Labor laws. The contractor has benefits, unemployment insurance, workmans compensation, etc.