Here's how to tell the difference between contractors and vendors.

Contractor or Vendor: How Do Businesses Classify for Correct Payment?

Posted December 14, 2017 by Justworks in Keeping Compliant
What’s the difference between a contractor and vendor, and how can your small business pay them correctly?

Questions often arise for business owners when it comes to correctly classifying and paying independent contractors and vendors. This article will help you sort through some of the key details.

What is the difference between an independent contractor and a vendor?

The IRS defines independent contractors as individuals who “offer their services to the general public…[where] the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”

Ultimately, when goods or services are purchased from a third party, labeling the third party an independent contractor or a vendor really has no significance for purposes of tax reporting.

In general, if a business pays $600 or more for services performed by someone other than an employee, it must report the payment using an IRS Form 1099-MISC. If the service provider is an LLC, or Limited Liability Company, you’ll report the amount using the LLC’s EIN. An LLC is a way for a service provider to create a business entity in order to have corporate protection — that includes benefits such as avoiding double taxation.

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Payments to a service provider may also be reported using an SSN if there is no separate business entity.

It’s also important to note that merely labeling someone an independent contractor or vendor does not mean they are not an employee. Whether someone is an employee and whether payments to them are subject to employment taxes is a fact-intensive inquiry, which focuses on, among other things, whether the business has the right to control the service provider’s work, financial aspects of the service provider’s work and the relationship between the service provider and the business.

What is the difference between an SSN and an EIN?

An SSN is a Social Security Number. SSNs are nine digits (xxx-xx-xxxx) and belong to US citizens and authorized residents.

An EIN is an Employer Identification Number. EINs are also nine digits, but formatted differently (xx-xxxxxxx).

Why would a service provider establish an LLC?

LLCs enjoy the protection of a corporate entity, even if it’s a one-person company. This helps protect the individual’s personal assets, and may provide additional tax benefits they wouldn’t get normally as an individual. Some LLC benefits include:

  • Separation of personal and company assets
  • No double taxation
  • Flexible profit sharing
  • Less paperwork than other business entities

Related: Which Business Structure Best Fits Your Company? [Quiz]

How do I know which way to pay someone and how to report it?

The decision is up to the person getting paid. The service provider will need to complete an IRS Form W-9 and you should use whatever Taxpayer Identification Number (TIN) is provided.

If you use Justworks’ platform as an administrator, you’ll send an invite to the service provider getting a payment. The service provider will provide Justworks with the applicable TIN — which may be an SSN or an EIN — and then we will properly report these amounts for you.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, legal or tax advice. If you have any legal or tax questions regarding this content or related issues, then you should consult with your professional legal or tax advisor.