This seems to be a perpetual topic for small business owners/entrepreneurs and with the focus of the most recent speech by President Obama being on job and job creation, I thought it appropriate to (re)visit this topic.
Independent Contractors (1099) versus Employee (W2). Which is which?
You may be asking yourself, so what is the controversy? What’s the big deal? For most employers, plenty!
Employers know that hiring an employee isn’t as easy as merely deciding to do so. There is a lot of moolah at stake. Moolah that could make or break their bottom line. Any tax preparer worth their salt would not suggest that you incorrectly classify an employee as an independent contractor because in the long run, if caught, it’s really not worth the time or the additional money in taxes, penalties and cost to hire an enrolled agent/tax preparer to defend your honor to the IRS…. now is it?
So here are the official 1099 classification guidelines from the IRS (Publication 15-A):
The guidelines fall into three broad categories (behavioral control, financial control, and relationship of the parties) and are considered all together, meaning all three must be met to use the 1099 status for an individual.
1) Behavioral Control
- Do you provide extensive instructions on how your work is to be carried out?
- Do you provide or require training on methods and procedures?
If YES: The IRS will suggest that an employer/employee relationship exists. Why? If you provide instruction and/or training, you control HOW the work is completed, it’s likely that you are hiring an employee, not an independent contractor.
Note: Instructions includes: how and where the work is done, what tools and equipment is used, where to purchase supplies and services, or order/sequence to follow to complete the work
2) Financial Control
- Expenses: Do you reimburse your worker for some or all of their business expenses?
- Investment: Do you provide for the worker or does the worker have to make an investment in order to work?
- Profit/Loss Opportunity: Does the worker make their services available/seek opportunities?
If you do not reimburse expenses, if an investment is made and is necessary prior to beginning work (such as investments in software or tools) and if the worker makes their services available & seeks business opportunities (advertises & markets themselves)…it is most likely that this individual is an independent contractor.
- Written contracts can be used to define and describe the relationship the parties intend to create
- Whether or not benefits are provided such as insurance, pension plan, vacation or sick pay
- If the engagement is indefinitely or for a specific project or period of time
- If the services represent a key aspect of the regular business of the company
Although a contract is not necessary, if you want to be clear on the boundaries and definition of an independent contractor relationship, it is advisable to have one. In it you can outline that benefits are NOT provided, the terms of the engagement (by specific project or period of time…the contract can be renewable) and the specific services to be rendered by the worker. Less will make an easy case for an employee-employer relationship.
If you still confused or not sure how to define your relationship with your worker or prospective worker, the IRS can help. If you would like them to determine whether or not a worker is an employee file: Form SS-8: Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. Good luck…