Independent Contracting And Outsourcing
Small businesses can use independent contractors and outsourcing to limit their tax liabilities. Both strategies, differing in relationship, scope, and execution, enable businesses to complete work outside their employee base.
Independent contracting involves hiring an individual or individuals to perform a specific service or task. The business contracts directly with the contractor(individual.) The independent contractor works autonomously and is not an employee of the engaging company. He/she is responsible for their taxes, tools, and schedules. The contractor’s scope or work is typically limited to specific assignments, short-term projects, or specialized tasks.
Outsourcing involves the delegation of entire functions or operations to an external company or service provider—it could be offshore: contracting work to foreign countries for cost savings; nearshore: outsourcing to neighbouring countries for cultural and time zone benefits; and onshore: hiring within the same country to maintain compliance with local regulations. The outsourcing partner may use teams of independent contractors or employees to complete the work. The scope of work in outsourcing is broader and often encompasses entire departments or processes (e.g., business process outsourcing: HR management, payroll process, customer service, &c.; IT management; knowledge process outsourcing (KPO,) engineering and design; and logistics and supply chain outsourcing, &c.)
Tax Liabilities – Payroll Taxes
In both strategies, the engaging company can minimize their tax liability, specifically their payroll tax liability, as the independent contractor or outsourced firm is responsible for their taxes. Payroll taxes include Social Security—employers pay 6.2% of an employee’s wages up to the annual wage base limit ($176,100 in 2025); Medicare—employers pay 1.45% of an employee’s wages with no cap; Federal Unemployment Tax (FUTA,)—6% on the first $7,000 of wages per employee but most employers qualify for a credit of up to 5.4%, reducing the effective rate to 0.6%; State Unemployment Tax (SUTA) varies by state, from .1% to 5%, and also depends on the employer’s unemployment claim history; Worker’s Compensation Insurance with rates calculated per $100 of payroll that can range from $.75 to $2.74 or more; while some municipalities impose additional payroll taxes, which vary widely.
Conclusion
Small businesses can reduce tax liabilities through independent contracting or outsourcing. Independent contractors are hired to perform specific tasks and operate autonomously, avoiding employer-employee tax responsibilities. Outsourcing involves delegating functions to external companies, whether offshore, nearshore, or onshore, providing cost savings, compliance benefits, or cultural alignment. Both methods minimize payroll tax liabilities since contractors or outsourced firms handle their taxes.
Notes
a. Payments to independent contractors for professional services, such as consultants, designers, marketers, or developers should be documented with invoices and reported on IRS Form 1099-NEC if they exceed $600 annually.
b. Payments to foreign subcontractors may require additional documentation, such as IRS Forms W-8BEN (used by individuals who are non-U.S. residents to certify their foreign status) or W-8BEN-E (used by entities, e.g., corporations, partnerships, and trusts.)
By Richard Thomas
