How do I handle payroll for employees and contractors?
Employees and contractors operate under completely different systems. Treating them the same way is one of the fastest routes to IRS problems. Employee payroll involves withholding taxes from every paycheck, depositing those taxes with the government, filing quarterly reports, and issuing W-2s at year end. Contractor payments are simpler. You pay the full agreed amount with no withholding, collect W-9s upfront, and file 1099s for anyone paid $600 or more.
For employees, start by getting an EIN if you don’t have one. Register with Michigan for state withholding tax and unemployment insurance. Collect a W-4 from each employee before their first paycheck. This tells you how much federal income tax to withhold. Michigan uses the same W-4 for state withholding.
Calculate withholding on every paycheck. Federal income tax based on the W-4, Social Security at 6.2%, Medicare at 1.45%, and Michigan income tax at 4.25%. You also pay the employer’s share of Social Security and Medicare, matching what you withhold from employees. Deposit these taxes on schedule. Most small businesses deposit monthly. Miss a deposit and penalties start immediately.
File Form 941 quarterly with the IRS reporting wages paid and taxes withheld. Michigan has its own quarterly filing requirements. At year end, issue W-2s to employees and file copies with the Social Security Administration.
For contractors, get a W-9 before you pay them anything. This gives you their legal name, address, and tax ID for 1099 filing. Pay them the full agreed amount with no tax withheld. Contractors handle their own taxes.
Track every payment to every contractor throughout the year. Your accounting software should show total payments by vendor. By January 31, file a 1099-NEC for any contractor you paid $600 or more. Miss this deadline and you face penalties per form.
Classification matters more than most business owners realize. The IRS has specific rules about who qualifies as an employee versus a contractor. If you control how, when, and where someone works, they’re probably an employee regardless of what you call them. Construction companies and other businesses that rely heavily on subcontractors need to be especially careful here. Misclassification triggers back taxes, penalties, and interest on all the payroll taxes you should have withheld.
Most small businesses use software or a Detroit payroll service to handle employee payroll because the calculations are complex and the deadlines are strict. Contractor payments are easier to manage yourself since you’re just tracking who you paid and how much.
If you have both types of workers, keep records completely separate. Different forms, different filing requirements, different deadlines. The system doesn’t need to be complicated, but it does need to be consistent and accurate.
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