Most small business owners are looking for ways to lessen company expenses. One way to do that is by employing independent contractors whose nature of work is similar to their full-time employees. One of the biggest benefits of employing an independent contractor is to reduce company expenses such as bonuses and employee benefits.
Generally, when you are hired for a job, you need to fill out a tax form to determine the type of worker you are. 1099 is used for an independent contractor status, and W2 is used by regular employees. W2 employees pay their taxes through automatic salary deduction paid by their employers, whereas a 1099 contractor needs to pay taxes quarterly themselves.
With the IRS enforcing strict taxation rules on companies and the classification of their workers, understanding the nature of the employee-employer relationship helps all parties involved distinguish how much tax contribution will be taken from the paycheck, and how payroll taxes will be deducted.
Why Employment Classification is Important
Most of the confusion between a regular employee or an independent contractor comes with the nature of work involved. Some companies are not clear on what the differences between a 1099 and a W2 worker. Classifying an employee incorrectly and failing to report worker taxes appropriately can have major consequences.
Employee misclassification has led to large lawsuits and significant penalties from companies who misclassified their workers as independent contractors. Take, for example, the Orange County Register in California which was forced to settle a lawsuit amounting to $22 million because of misclassifying their workers.
Another poignant example is of three construction companies who were ordered by the Department of Labor to compensate employees for back pay and damages totaling $491,100 because they were misclassified as independent contractors.
Who Needs a 1099?
The need to understand the nature of the relationship between a company and the status of its workers must be discernible before you commit to hiring a worker. One way to determine if someone is a 1099 contractor is if:
- The worker doesn’t need full instructions or management on how to get the job done.
- The worker doesn’t have a schedule or hours.
- The worker is not using tools or equipment provided by the employer, such as a tablet or computer.
- You don’t have to provide training to do the job they are coming in to do.
- The worker is a freelancer who works for other companies in addition to yours.
As a general rule of thumb, if a worker is allowed to work independently without much instruction from a company, then he or she can be considered for 1099. A good example of this is if a company hires you to work for janitorial services and they do not meddle with how you should polish the floor, how you should take out the trash, or what times you need to do your job. If your employer considers you to be the master of your own time, and if you do not require job training because you have been trained before, then 1099 employment status is more appropriate.
Don’t Call Your Independent Contractors “1099 Employees”
Using the term “1099 employees” is a common practice, but one that is nonetheless incorrect. The term “1099 employee” is contradictory. If someone is your employee, then the tax classification radically changes. If you have people doing work for you who qualify for 1099 employment status, then the most appropriate term is “independent contractor.”
Determining Correct Employment Status is No Laughing Matter
The implications of a worker misclassification can have a tremendous effect on any company or employer because of the stringent employer tax liability. This often leads to huge penalties that can be crippling to any business.
Still unsure how to manage the tax status of your independent contractors and W2 employees? Let’s chat—Connie Jabara of Sunflower Benefits Group can provide you with the counsel you need to properly classify your employees and other workers.