Legal and Tax Ramifications of Paying Subcontractors
May 17, 2013 8:17 AM   Subscribe

I've been doing a fair bit of freelance work, and it's to the point now that I have to sub out certain tasks that are outside my area of expertise. I don't want to make my clients cut multiple checks if I can avoid it–want them to just deal with me to keep it simple and neat. However, I do not want to be on the hook for income that is actually going to a sub. What to do?

I do not own a corporation or partnership or anything like that.
I live in Delaware County, PA (10 miles from Philadelphia, 10 miles from Delaware).
Most of my freelance business is in advertising; some in marketing consulting.
I am unlikely to be able to afford an attorney.
I have a pretty good friend who is an accountant, I am asking him as he provides services to small businesses.
I am tight with my subcontractors–known them for a long time, work well together, and def. want to pay them in a timely and fair way.
I am willing to pay fees and do paperwork to form a legal entity, but must keep it within reason.

posted by Mister_A to Work & Money (20 answers total) 3 users marked this as a favorite
Let's start here:

I am unlikely to be able to afford an attorney.

Then you probably aren't charging enough. This is one of the costs that the best freelancers build into their fees.

Moving on:

I do not own a corporation or partnership or anything like that.

That's easily fixed, and you should probably look into forming some kind of entity. LLCs are pretty popular, but there's a variety of solutions that might work. Turns out setting up one of these is trivial. Filing fees are a few hundred bucks at best.

I have a pretty good friend who is an accountant, I am asking him as he provides services to small businesses.

You'll need this more than you'll need a lawyer. You should have a lawyer on speed-dial, but only talk to him once or twice a year, if he's doing his job right. You should probably talk to your accountant every week, if you're doing this as a full-time business. Even part time, several times a month wouldn't be unreasonable.

I live in Delaware County, PA (10 miles from Philadelphia, 10 miles from Delaware).

If you aren't already aware of Philadelphia city taxes, you really need to be. They're a bitch.
posted by valkyryn at 8:30 AM on May 17, 2013 [1 favorite]

Response by poster: I'm going to restate the question: How should I handle paying my subcontractors without exposing myself to excess tax liability or other expense?
posted by Mister_A at 8:37 AM on May 17, 2013

The simple answer is: Paying subcontractors is a business expense. Get an EIN, and you'll issue them 1099s at the end of the year for the amount you've paid them. And be careful that you are indeed employing them as subcontractors and not employees, because this does open you up to that excess tax liability if you aren't careful.

In fact, I'd be surprised if you don't already have an EIN, my clients insisted on it as a part of the "no, really, you're a contractor" part of the talk.

The complex answer is what valkyryn said.
posted by straw at 8:47 AM on May 17, 2013

Response by poster: So how does one get an EIN? Do I have to form a corporation or something? That's what I'm trying to get advice on.
posted by Mister_A at 8:49 AM on May 17, 2013

And be careful that you are indeed employing them as subcontractors and not employees

To this point: make sure your contract with them specifies that they are liable for all taxes and other government payables.

But yes, you DO want to have subcontractors. You mark up their rates to your client to make up for the admin overhead.
posted by DrJohnEvans at 8:50 AM on May 17, 2013

Response by poster: OK - I have the subcontractors lined up. They are not employees. They are subcontractors. That is stipulated. What do I do now? Just write them a check from my personal account? Or should I form some legal entity that accepts and disburses payments?

More details: I have been freelancing for years while working my regular gig; just lately, the work has assumed a scope that I can't do it all on my own. I am not asking for advice on rate markups, or anything like that. I would like someone to give me some advice on what is the best way to go about paying people, because I am concerned that if a check comes in my name, I have a tax liability for the total amount, even if I'm paying most of it back out to a sub.
posted by Mister_A at 8:58 AM on May 17, 2013

And be careful that you are indeed employing them as subcontractors and not employees

To this point: make sure your contract with them specifies that they are liable for all taxes and other government payables.

As far as the IRS is concerned, whether someone is an independent contractor or an employee is not dependent on the contract you have signed with them, but on the circumstances of their employment. See this page for more info.
posted by ultraviolet catastrophe at 9:07 AM on May 17, 2013 [1 favorite]


Seriously, get a lawyer, and get an accountant. You're asking for professional advice. You want professionals. If your accountant friend does work with small businesses, s/he should know lawyers who are affordable for people in your position.
posted by joyceanmachine at 9:16 AM on May 17, 2013 [3 favorites]

Response by poster: I am not asking about the definition of subcontractor v employee, although I would have welcomed that information in the context of an answer to the question I am asking. I am asking for some ideas about reasonable ways to do this. Again, the big change is this: Now I have to sub some work out.

I promise you this will not be my only source of information and advice. I am trying to get a few ideas on how to approach this. I will continue to research, I promise you. This amazing outpouring of specific and topical information is one of the early chapters in this story.

Here are a few examples of the kind of answer I'm looking for:

-"I was in a similar situation, and formed a [legal entity x] in Delaware. It cost me about [$X] to establish and [$Y] yearly to maintain."

"Actually, as long as it's below [$A], you are fine just itemizing subcontractor pay under [Schedule x]; then you are not liable for state, local, or federal tax."

So. Those are not real answers; they are templates for answers that I might find valuable. Do not judge me harshly because I am asking you for advice in this forum; this is not my only source of advice.
posted by Mister_A at 9:24 AM on May 17, 2013

You can get an EIN online from the IRS.

I have done variations of this in a number of different locales. The first time I did this I just got a county and city business license and didn't have any subcontractors. The second time, I spent a few hundred bucks for some time with a local strip-mall lawyer, and a local bookkeeper. Honestly: Do this. For a couple of reasons:
  1. There are local zoning issues with where the address of your company resides. If you have a corporation or a DBA ("Doing Business As" alias for a sole proprietorship or partnership), you'll need an address registered with it. In my city that's as simple as a $45/year business license, except that you also have to get a use permit, which cost about $500. My county demands a few bucks and a newspaper legal notice every couple of years. Your city and county will be different.
  2. There are reasons to incorporate, and reasons to not incorporate. This is legal advice. Legal advice is worth what you pay for it.
  3. I think Quicken Home & Business will deal with issuing your 1099s, but the first time you do it is totally worth paying a bookkeeper to guide you through the details.
Really: If you have a business, you're going to want to pay people to help you run that business. Start that. Right now. You're not going to get accurate details tailored to your specific place for free on the Internet. You're especially not going to get that if you don't put "EIN" into Google and read the first hit, which is the IRS page that answers some of these structural questions.

So find a couple of local people who can walk you through this and take care of the details. They specialize in this stuff so you don't have to. If you have a viable business, it will be cheaper to pay them to do this for you than for you to get mired in the specifics.
posted by straw at 9:48 AM on May 17, 2013 [4 favorites]

The (at least) two lawyers who have showed up in this thread aren't giving you the answers you want because you're doing the equivalent of walking into, say, a dentist's office and saying something like, "I know about toothpaste, and I've heard of fluoride. Please tell me reasonable steps for removing this cavity, because I probably can't afford a dentist. By the way, fraster hosepipe!"

Your question and your responses in this thread use words associated with law and tax work indicate that you're sorta familiar with the terms, but don't actually know what they mean. That is dangerous, because the intersection between tax and labor/employment is a complicated area.

Seriously, you're making money. Hire professionals to take care of you, so you can stop worrying about collating advice from random-ass Internet sources.
posted by joyceanmachine at 9:50 AM on May 17, 2013 [2 favorites]

Here's what you need to know: the money your clients pay you is revenue, but the money you pay out to subcontractors is a business expense that you deduct from total revenue to arrive at your business's profit on which you pay income tax. Any provider that you pay more than $600 in a year you must get a W-9 from and in turn send them a 1099-MISC. I do not believe you need an EIN to file a 1099 -misc nor do you need to incorporate or pay them from a separate account. You can get more details about 1099-misc paperwork from the IRS website. I can't tell you about it in any more detail because I've yet to hit the threshold with a subcontractor. I work in an industry where job values are relatively small and most service contracts are implicit.
posted by drlith at 9:54 AM on May 17, 2013 [1 favorite]

Response by poster: Thanks to the people who addressed my request. joyceanmachine, forgive my impertinence for conducting some preliminary research on how I may address this concern without first consulting an attorney! It was foolish to think that there were reasonable steps that could be taken between "conduct preliminary internet search" and "hire expensive professional."
posted by Mister_A at 10:09 AM on May 17, 2013

Best answer: You don't necessarily need a lawyer or an accountant. Depending on the complexity of your business, you may be able to do all of this entirely on your own.

Let's assume the simplest case. You are a sole proprietor that does contract work for clients. The clients give you a 1099-MISC at the end of the year which reports how much they paid you. Likewise, if you use sub-contractors, you must report to the IRS how much you paid them by sending the IRS a 1099-MISC for each sub-contractor you pay.

To fill out the 1099-MISC, you need your tax identification number (TIN) and the sub-contractor's tax identification number. In both cases the TIN could just be your social security number and the sub-contractors SSN. If you don't like giving out your social security number, you can apply for an EIN on line. It takes just a couple of minutes, as Straw explained above. You get the sub-contractor's TIN by having them fill out a a W-9 before they start working for you.

If these are sub-contractors and not employees, then you are not responsible for reporting any of their taxes. You just write them a check and keep track of the annual total before filing the 1099-MISC. One copy goes to the IRS and the other you send to the sub-contractor so they can do their taxes. They are responsible for their own taxes just as you are responsible for your own taxes.

I recommend you use something like Quicken for Home and Business to keep track of your business income and spending. Then use something like TurboTax for Home and Business to do your tax return. You can probably figure this out on your own, but you may want to have a tax preparer help you the first year.

So in this simple case, sub-contracting is trivial. Get a TIN from the sub-contractor via a W-9. Write them a check for each payment. At the end of the year fill out a 1099-MISC with the total and mail one to the IRS and one to the sub-contractor. That's it.

When it's time to do taxes, you get 1099's from your clients that report how much they paid you. This is your gross income. You subtract from the gross all the payments you paid to sub-contractors.
posted by JackFlash at 10:22 AM on May 17, 2013 [1 favorite]

What JackFlash said, although consulting at least an accountant would be a good idea. They can help you get a framework set up to avoid headaches down the road and recommend if you need to see a lawyer, etc. Two piece of additional advice I would add:

- you mentioned paying them out of your own account. Set up a separate account for your biz. It will make your accounting a lot easier. It doesn't have to be a special business account, just something separate from your personal money account

- when you send those 1099-Misc out, they are supposed to be sent out by the end of January, and then the final one sent to the IRS by the end of Feb. That's so your subcontractors know what you are reporting to the IRS, and the month delay between the deadlines I assume is to find/fix/reconcile any errors.
posted by snowymorninblues at 11:06 AM on May 17, 2013 [1 favorite]

While a separate account might be helpful, especially if you aren't particularly organized in your bookkeeping, it isn't absolutely necessary. As a sole proprietor with a simple business, you can pay expenses out of your personal checking account, deposit checks in your personal account and use your credit card for business expenses. You just have to keep good records showing every dollar of business income and every dollar of business expenses. You can do this in Quicken by simply tagging all business related transactions. It doesn't require separate business accounts.

The goal is to keep everything as simple as possible. Don't add unnecessary business complications unless you really need them. That way you spend less time on bureaucracy and more time earning money in your business.
posted by JackFlash at 11:25 AM on May 17, 2013 [1 favorite]

I am a bookkeeper (part-time) but I am not your bookkeeper. This is not complicated. The only part of it is that you absolutely need to keep good records.

1. Your sub-contractors should fill out and send to you a W-9 form. Just have them all do it before you start working exchanging any money. Keep these forms.

2. When they do work for you, they send you an invoice for that work. You pay them out of your own money. Keep track of how much you pay each of them.

3. Do the work for your clients using, if necessary, the work these sub-contractors do for you. Get paid for that work. Unless your clients have some "no sub-contractors or we must approve sub-contracted work" clauses in their contracts with you, what happens between you and the sub is not their business.

And now of course the tricky wicket when you have sub-contractors is balancing out the timing of getting paid for the work you do for clients and paying sub-contractors in a timely fashion so you can keep them happy as well. But hey, that's rich people problems.

At tax time, you need to do this:

1. You need to total up all of the money you have paid in that calendar year to each sub-contractor. For each of them that is over the current IRS threshold (which changes but was $600 last year) you have send them a 1099-MISC form. You need to do that before Jan 31st of 2014. That form ALSO needs to be filed with the IRS. There are services online that can help you do this. It isn't hard at all.

2. For your own taxes, you would add up your income, deduct your expenses WHICH NOW INCLUDES the expenses of these sub-contractors and pay for the tax on what's left over. If you are doing so much work that you need to hire sub-contractors you should absolutely pay the $400-$800 I see accountants charge for doing these kinds of returns. And that will be on the cheaper side if you do a good job of keeping your own records (Quickbooks or Freshbooks or similar are very helpful and relatively cheap, but a clean, updated and documented Excel spreadsheet is also a fine option).
posted by marylynn at 11:49 AM on May 17, 2013 [1 favorite]

Mister_A, you seem to be looking for easy solutions to what could be extremely hard problems. You do not want to get into tax trouble because it never ends. Set your business up in a business-like way as all the commenters are telling you. Paying a lawyer and paying your accountant friend for the advice you need is cheap in the long run.
posted by Cranberry at 11:54 AM on May 17, 2013

Virtually all of the questions you have posed are for your accountant, and you seem to be on your way there.
posted by yclipse at 12:20 PM on May 17, 2013

One more note: A few years ago at a charity auction, we bought a "have your taxes done with a professional tax preparer." We had her help do our taxes for a few years, then we moved and went back to TurboTax, but...

You're asking this question after having been paid via 1099 for a few years. This is fairly elementary stuff, businesses have expenses, anyone being paid via 1099 is running a business. What I realized on my latest read-through is that you probably aren't deducting nearly as many of your expenses as you could.

Professional tax preparers tend to be overly aggressive on pursuing deductions. I think I once read a study that suggested you were more likely to be strictly within the IRS rules if you did your taxes yourself vs paying someone else to do them, but those sessions with the professional preparer were eye opening for us. All sorts of deductions we hadn't thought to claim.

But based on your question, I suspect that finding a bookkeeper who does taxes too may open up all sorts of expenses that you're not accounting for currently. Paying that person five hundred or a thousand bucks to coach you through what you need to be doing can easily save you that in taxes.
posted by straw at 4:49 PM on May 17, 2013

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