The Problem with a 1099 Employee VS. a 1099 Worker
Augmenting a workforce with 1099 workers can be an effective way to rapidly adjust to changing business needs. Not only is this flexible work arrangement beneficial to dynamic organizations, it has become an attractive option for a growing number of talented professionals.
The term "1099 worker" originates from the IRS Form 1099-MISC used to report payments to independent contractors. As independent contractors become more prevalent, many employers and workers have difficulty understanding the qualities that distinguish these independent contractors from employees. It is important to understand that a 1099 worker is a contractor - not an employee.
Changing Status from an Employee to a 1099 Independent Contractor
In some situations, individuals may request to change their status from W-2 employees to 1099 workers in exchange for higher wages or increased flexibility. This transition should only occur with caution and after careful consideration. Changing an employee to a 1099 worker requires more than terminating the employee, canceling benefits, and paying out vacation leave (if applicable). In fact, it is imperative that the worker actually qualify for 1099 status under the guidelines provided by the IRS. Misclassification can result in substantial tax bills and penalties for the employer as well as the worker.
How to Determine if a Worker Qualifies for 1099 Status
To determine if a worker qualifies for 1099 status many organizations use the former IRS 20 Factor Test. While this still provides a strong indication of the appropriate classification, the IRS has since revised the test to include multiple factors within three main categories. These factors are defined in IRS Publication 1779 and are intended to identify the level of behavioral control, financial control, and the type of relationship between the organization and the worker. One of the factors most commonly misunderstood by organizations is the general right of 1099 workers to determine the means and the methods for accomplishing their work.
For the purpose of ensuring compliance with federal tax regulations, organizations and workers may request a free determination of work status by filing IRS Form SS-8. To complete the form, the organization or the worker must provide specific information in the three main categories identifying the level of control and validity of the worker's independence. For an independent contractor status to exist, the IRS does not require that a relationship meet all qualifying factors. When making a determination, the IRS considers and places weight on all circumstances surrounding the relationship.
How to Differentiate Between a 1099 Versus 1099 Employee
Once individuals are properly identified as independent contractors, and there is a decision to employ them, the organization should furnish legally binding business contracts that include, but are not limited to, the scope of work, terms of the engagement, fees and invoicing, and a clause for termination.
It should be clear to all parties that 1099 employees do not exist. Independent contractors or 1099 workers are not employees, and therefore do not receive:
- social security,
- workers compensation,
- health insurance;
- or any other benefits or services provided to employees.
They also have the ability to direct and control how they perform their work, and they control the financial and business aspects of their job.
Avoid potential litigation, tax bills and penalties by understanding the differences between employees and 1099 workers. Work with your Human Resources professional to ensure proper classification and if any uncertainty exists, consult with an employment attorney or file IRS Form SS-8 for a determination. Here's a couple other articles my colleagues wrote on the subject for further reference: Independent Contractors vs. Employees: How Misclassifying Employees Can Cost your Business and How to Determine if They Should Be a 1099 Contractor or W-2 Employee.