Can i pay an employee with a 1099

The Internal Revenue Service requires all businesses that hire workers to file an annual form reporting wages paid and taxes withheld for each worker. Form 1099 is used for workers who are classified as independent contractors and Form W-2 is for employees. While most workers will get only one of these forms, sometimes the same worker will receive both. There are some major differences between the 1099 vs W2 as defined by the IRS.

Contractors and Employees

The IRS will presume that a worker is an employee unless there is evidence to the contrary. This is largely because the required tax withholding from an employee's paycheck is the major way the IRS enforces collection of taxes from individuals.

A worker classified as an independent contractor by the employer is not subject to any tax withholding and receives all of his gross wages. The IRS requires such a worker to meet certain standards to be legally classified as an independent contractor.

Independent Contractor Test

Only an independent contractor can legally be given Form 1099. A worker must meet certain standards to be classified as an independent contractor. To figure out whether someone is an employee or an independent contractor, the IRS will examine the type of work, the nature of control the company exercises over the worker and the relationship between the worker and employer.

Generally, a worker whose behavior and finances are controlled by the employer will be considered an employee. For example, a worker who must have his duties supervised and controlled by the employer is an employee. A worker who has all of his expenses paid for by the employer will likely be considered an employee.

There are three primary metrics, known as common law rules, by which the IRS determines whether an individual is an employee or independent contractor: behavioral, financial and type of relationship. Behavioral indicators express the level of independence of the individual in question. Financial aspects include how much of the business aspects of work are controlled financially by the contracting company or employer. Finally, the type of relationship indicates the duration of the relationship and whether there are contracts or benefits.

Concurrent or Separate

There are two situations in which an independent contractor can receive both Forms 1099 and W2 from the same employer. The first is if the worker performed duties as an employee and independent contractor concurrently for the same employer. Basically this means the worker had a job as an employee and another job as a contractor for the same company.

The other situation is where the worker held these two jobs at separate times during the same tax year for the same employer. Sometimes, an employer will issue a bonus through Form 1099 in addition to a W-2 for wages. If this happens, seek to get the 1099 cancelled and instead have the bonus added to a corrected W2. Employee fringe benefits should also not be reported on a 1099.

Switching from contractor to employee requires a completed W4 and the employer must treat the new employee as any other. Converting an employee to an independent contractor requires firing the employee and then having them fill out a W9. Axios HR stresses that if an individual switches roles for the same company, clear distinctions must remain to uphold either the employee or independent contractor categorization.

Risks and Consequences

Since the IRS so heavily relies on tax withholding, it will perform audits on employers if there is a suspicion of wrongly classifying workers as independent contractors. Filing both a 1099 and W2 for the same worker will likely cause such an audit. This is particularly true for the concurrent scenario. If the IRS rules that a worker was wrongly classified as an independent contractor, there are significant tax penalties imposed on both the employer and employee.

Sometimes the status of a worker is not clear. A common example of an unclear status would be a nanny who provides childcare in the home of a family. In most cases, the IRS deems the nanny to be a household employee and not a contractor. The IRS utilizes Form SS-8 to determine status in ambiguous cases.

Determining Status

A way to avoid such negative consequences is for either the employer or employee to file Form SS-8 in advance with the IRS, which will result in the IRS officially determining the proper worker classification. It can take up to six months to receive a response from the IRS after Form SS-8 is filed. A business that hires multiple individuals with an ambiguous status should file a Form SS-8 for each such employee. Individuals who feel they have been misclassified as independent contractors can also seek recourse against paying full self-employment taxes by filing Form 8919 to report an employer.

Wednesday, February 2, 2022

While many employers use the term "1099 employee" as a means to distinguish independent contractors from the company's W-2 employees, no such term exists from a legal standpoint. 

In fact, in addition to being inaccurate, this term is hazardous and could be costly for companies.  A common mistake made by employers across the nation is misclassifying its workers as independent contractors as opposed to employees, and this issue is only exacerbated by erroneous terms such as "1099 employee."  Though it may seem to many that calling workers "1099 employees" is merely a use of inexact terminology, it should be noted that this lack of precision could lead to pitfalls, such as failure to withhold and pay taxes, operating without proper insurance, and United States Department of Labor ("DOL") audits. 

What's the Truth Behind "1099 Employees"?

A "1099 employee" is a misnomer employers use to describe independent contractors.  While the term has been coined by many and is commonly used by small business owners, the Internal Revenue Service ("IRS") generally refers to these workers as nonemployees.  A 1099 refers to the tax form companies must provide to independent contractors for work performed throughout the year.  Business taxpayers must report nonemployee compensation of $600 or more to the IRS using a Form 1099-NEC, Nonemployee Compensation. 

Independent contractors are not protected by Equal Employment Opportunity laws, requirements to provide minimum wages and overtime pay, workers' compensation laws, or unemployment compensation laws, among other regulations.  Further, independent contractors are not entitled to many benefits offered by employers.  Due to the Form 1099, independent contractors self-report their earnings, meaning employers are not required to withhold taxes and payroll deductions for independent contractors.  All of these advantages generally incentivize employers to use independent contractors or at least claim their employees are independent contractors because such classification can result in significant cost savings.  Additionally, the relationship can be mutually beneficial to the independent contractor because they commonly receive greater control over their work environment, schedule, and methods used to complete the job. 

What's the Problem?

The distinction between independent contractors and employees is a complex determination that employers must make regarding each worker.  There is no single test to evaluate a worker's status as an independent contractor or an employee for all purposes, which further complicates the issue.  The decision of whether workers are considered independent contractors or employees is assessed by federal courts through a list of factors, each of which has various issues that require further analysis, commonly known as the "Economic Realities Test."  The cornerstone of the factors is the employer's right to control the performance of the worker as they complete the task assigned.  The six factors utilized by courts are:

• The degree of control that the employer has over the manner in which the work is performed and by whom;

• The worker's opportunities for profit or loss depends on the worker's managerial skill;

• The employer's and worker's relative investment in equipment or material;

• The degree of skill and/or independent business judgment required for the work;

• The permanency of the working relationship; and,

• The degree to which the services rendered are an integral part of the employer's business. 

Although this test was scheduled to be published and expressly adopted by the DOL, the final rule taking such action was withdrawn prior to taking effect.  In addition to the complication of the test and the fact that the DOL has not further addressed the issue, the misnomer "1099 employee" completely misses the objective.  The ultimate determination is whether a worker should be classified as an employee or an independent contractor who reports compensation via a Form 1099.  The imprecise label "1099 employee" combines the two classifications, creating further confusion within the intricate issue.  

Conclusion

Calling a worker a "1099 employee" can be an expensive mistake for a company.  Independent contractors are not covered by workers' compensation insurance, are not subject to the company's unemployment or payroll taxes, and do not receive overtime or minimum wage.  However, employers must ensure that all of these protections are maintained for employees.  Calling a worker a "1099 employee" could potentially cause employers to pay for pricey insurance, payroll systems, and wages that are not otherwise required if the worker is actually an independent contractor.  On the other hand, if a worker is truly an employee, then the company is risking six-figure workers' compensation claims, wage and hour claims seeking two years' back pay and overtime wages, and audits by the Department of Employment Security, the IRS, and the DOL.    

While removing the term "1099 employee" from your vocabulary will not solve the issues associated with the difficulty of classifying workers, the use of this term further complicates the distinction between independent contractors and employees.  Understanding the inaccuracy of this terminology could be the first step in avoiding a six-figure penalty associated with misclassifying workers.  For further guidance to avoid misclassifying workers, you should evaluate the worker's position and job duties with your attorney and determine the appropriate measures to implement.

© 2022 Ward and Smith, P.A.. All Rights Reserved.National Law Review, Volume XII, Number 33

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