Employers are not required to withhold taxes from independent contractor earnings. Instead, they file information returns to the Internal Revenue Service and state authorities, indicating the amount paid in wages to the independent contractor. This information is also provided to the contractor on IRS Form 1099-MISC.

The Internal Revenue Code and various state laws impose substantial penalties on employers for improper classification of employees as independent contractors. Likewise, the Code imposes penalties and fines upon independent contractors who either fail to report income or who do not file self-employment quarterly returns. Additionally, the independent contractor will have to back-pay all taxes and social security deductions accrued during the misclassified period, in addition to those currently due.

Penalties to employers for failure to withhold income taxes are generally equal to 1.5 percent of the wages, plus 20 percent of the social security and medicare taxes that should have been paid by the employee. There is also a liability for the unpaid portion of the employer’s portion of the social security and medicare taxes.