Bookkeeping for Employees Versus Contractors: A Comprehensive Guide

Bookkeeping is an essential part of any business. It helps maintain accurate financial records, which are crucial for managing cash flow, making business decisions, and filing tax returns. However, the process can vary based on the type of workers a business has – employees or contractors. Here's a comprehensive guide on how to do bookkeeping for both.

Payroll for Employees

Regular Salary Disbursements

When you hire an employee, you agree to pay them a set salary or hourly wage. This is usually disbursed bi-weekly or monthly and must be recorded as an expense in your books.

Deductions and Contributions

Unlike contractors, employee compensation involves various deductions like social security, Medicare, federal and state taxes. Employers also must contribute to unemployment taxes and workers' compensation insurance. These should all be accurately tracked and recorded.

Benefit Expenses

If your business offers benefits like health insurance or retirement contributions, these costs must be incorporated into your bookkeeping system.

Payments to Contractors

Flat or Project-Based Fees

Most contractors are paid a flat fee or on a project basis. These payments need to be recorded as expenses in your books when the service is delivered, regardless of when the payment is made.

No Deductions

Since contractors are not employees, you don't withhold taxes from their pay. But, you do need to keep track of how much you pay each contractor for year-end 1099 reporting.

No Benefit Expenses

Contractors typically do not receive benefits from the businesses they work for. Therefore, you won't have any benefit expenses to record for contractors.

Year-End Tax Forms

W-2 for Employees

For each employee, you'll need to prepare a W-2 form that outlines their earnings, withholdings, and deductions for the year. This form is then sent to the IRS and the employee.

1099-NEC for Contractors

If you paid a contractor $600 or more during the tax year, you'll need to prepare a 1099-NEC form. This form is sent to both the contractor and the IRS.

Record Keeping

Proper record-keeping is critical, whether you're dealing with employees or contractors. Keep track of all payments, deductions, and tax forms. This will make tax time less stressful and ensure you're prepared in case of an audit.

Bookkeeping for employees and contractors can seem complex, but understanding the differences and requirements can make the process manageable. Always remember the importance of accurate record-keeping and consult with Steadfast Bookkeeping Solutions if you need assistance. We are happy to put together a bookkeeping and payroll package for you!