Key Takeaways
1. 1099 employees are becoming more popular in the wake of the COVID-19 pandemic.
2. 1099 employees are freelancers and independent contractors who are treated differently than traditional W-2 employees for tax purposes.
3. An employer exerts significantly less control over how, when, and where a 1099 employee completes a project than a W-2 employee.
4. The rules and regulations for 1099 employees are different than for W-2 employees, and employers must fill out separate tax forms.
5. It is important not to misclassify W-2 employees as 1099 employees or else an employer may be subject to penalties and hefty fines.
In the wake of the COVID-19 global pandemic, more and more businesses and employees are opting for a less formal working relationship that offers flexibility. With the rise of freelance work, there has also been growing confusion surrounding ‘1099 employees’ (a popular name for independent contractors), the benefits, and the tax implications of hiring them.
For support with the process, many companies are opting for Contractor Management Outsourcing to easily begin engaging 1099 employees/independent contractors.
Before hiring a 1099 employee/independent contractor, it is important to become familiar with the laws and rules surrounding their hire. This ensures that you aren’t surprised with any unexpected tax implications, or misclassification penalties, down the line.
What is a 1099 employee?
A ‘1099 employee’ is not technically an employee at all, but an independent contractor (sometimes called a freelancer), who is usually hired for a finite period of time, or on an ‘ad hoc’ basis. Common examples include individuals hired to create social media posts, write website content, edit photos and film, or design a logo. 1099 employees are often referred to as the ‘contingent workforce‘.
Unlike traditional employees (often known as ‘W-2 employees’, in reference to the IRS form used with these individuals), a 1099 employee/independent contractor does not receive a benefits package or a salary. In addition, they are not subject to workers compensation and certain labor laws. A 1099 employee/independent contractor essentially runs their own business, and often works for multiple clients at a time.
Though the terminology can be a bit confusing, it is important to classify a 1099 employee/independent contractor correctly in order to avoid penalties and fines associated with misclassification (more on this below). In light of this, we discuss here some of the key questions to ask when engaging 1099 employees/independent contractors.
1099 Employee vs. W-2 Employees
In deciding whether an individual is a 1099 employee/independent contractor or a W-2 employee, the business should ask three questions:
1. Does the business control how the individual does their job?
2. Does the company control how the individual is paid and whether or not they are reimbursed for expenses and supplies?
3. Is there a written employment contract, especially one referring to explicit benefits, like vacation days, associated with the work?
We consider each of these questions in greater detail below:
- Behavioral Control
- The first question addresses controlling the behavior of the individual and how the project is completed. A W-2 employee is usually required to work during particular hours, in a particular place, or is trained in a particular way by the employer. An independent contractor, on the other hand, usually works on their own schedule and is already competent in their field without requiring extensive training.
- Financial Control
- The second question addresses financial control. A W-2 employee is usually paid on a particular schedule (such as bi-weekly), and in accordance with policies set by the employer. Many W-2 employees are reimbursed for additional expenses that are necessary for their work such as gas mileage, internet and office supplies. By contrast, an independent contractor usually controls their own payment schedule in agreement with their client, and sets their own rates. They are responsible for their own business expenses, which are usually tax-deductible.
- Nature of the Relationship
- The third question examines the general nature of the employment relationship through evidence such as written contracts and benefit agreements. While a written contract doesn’t necessarily mean that someone is a W-2 employee, a contract with a salary and defined benefits suggests that an employee is more than a mere contractor working on a temporary basis. A 1099 employee may still have a contract with the business but it will usually clarify that the individual is not entitled to any of the benefits of an employee.
- For more information read What Is an Independent Contractor Agreement? and The Complete Guide to Independent Contractor NDAs.
What are the 1099 employee rules?
1099 employees/independent contractors are responsible for paying their own taxes and they are not protected by the same set of labor laws as W-2 employees, such as anti-discrimination/equal employment opportunity, and overtime laws. Many companies find this aspect of hiring an independent contractor desirable because it lowers compliance costs, saves money, and gives more flexibility to the company and the independent contractor.
The main rule to follow is that a company must be absolutely certain that an individual is an independent contractor before treating them as such for tax purposes. If the independent contractor contests their status as an independent contractor and the IRS agrees, a company might be left with massive fines and penalties for failing to pay the appropriate taxes and benefits. This makes it exceptionally important to classify a 1099 employee accurately.
What paperwork is needed for a 1099 employee?
When tax season rolls around, a business which has hired independent contractors needs to fill out specific paperwork. In past years, employers filled out a 1099–MISC form that covered various sources of miscellaneous income. However, the rise of the gig-economy and freelance work has encouraged the IRS to create a new form solely for independent contractors, the 1099-NEC.
Employers must first get personal identifying information from their independent contractor including their address and tax identification number. Using this information, the employer must fill out the 1099-NEC form for any independent contractor that has been paid $600 or more throughout the year. This form is then reported to the IRS and a copy is sent to the independent contractor to use during their own tax preparation.
If you aren’t sure if an individual is an independent contractor, you can file an SS-8 form with the IRS before tax season begins. The SS-8 form requests specific information about the nature of the working relationship so that the IRS can make a definitive decision on the status of an employee before tax season. This tool protects a company from potential misclassification penalties and is valuable in potentially ambiguous situations.
Conclusion
In your search for new talent, Horizons can help your company recruit, hire and manage a team of 1099 employees/independent contractors in the United States, and around the world.
Our team will be able to advise you whether engaging an independent contractor or a W-2 employee through an Employer of Record solution is more appropriate.
Frequently asked questions
The number ‘1099’ refers to the specific tax form that employers must complete when hiring independent contractors as soon as tax season comes around. This form is used in lieu of the more common W-2 form. Since 1099 employees are normally paid directly without withholding estimated taxes, both the employer and 1099 employee must report certain information to the IRS in order to comply with the relevant tax law at the end of the year.
A 1099 employee needs to pay federal and state income tax, and an additional self-employment tax that contributes to social security and Medicare. Unlike W-2 employees, 1099 employees/independent contractors do not have an employer withholding and paying income tax and payroll tax on their behalf. The flip side is that many 1099 employees can write off valuable tax deductions for work expenses such as internet, travel expenses, electronics, and the home office deduction.
