Ah, the age old question, should I hire this person as an employee of the company (W-2) or should this person be an independent contractor (1099)? To answer this question, we need to understand what this terminology means in order to make an assessment of how we are going to approach the classification of the individual. Let’s start :
What is a W-2 or W-2 type of employee?
- Simply put, a W-2 type of employee is an employee that has their income recorded by their employer and reported to the Internal Revenue Service (IRS) through the W-2 Wage and Tax Statement form. This form provides the IRS information about the annual income, taxes, and potential benefits of an employee. The data is reported to the IRS and at the end of the year the employer provides the employee with a reconciled W-2 form that will be used by the employee to complete their annual tax return. An employee that has worked with a company during a particular year (regardless of how long) will receive, at the end of the year, a W-2 form from every employer they have been paid to perform work for throughout that year.
- In order to determine if a person should be a W-2 employee, I have compiled a couple of questions you can consider asking yourself to help guide the determination. If you answer “Yes” to any and/or all of the questions, then you probably should be classifying the person as a W-2 employee:
- Will this person be working on site?
- Will I (the employer) be providing this person an assigned schedule?
- Will this person be required to represent the company?
- Will this person be eligible for benefits?
- Will I (the employer) have control of the employee’s tasks and responsibilities?
- Will this person be using only equipment provided by the company?
- Will I (the employer) be providing this employee training to do their job?
What is a 1099 or 1099 type of individual?
- A 1099 type of individual is someone that manages their own financial responsibility and is in business for themselves, typically offering a service. Companies that hire these types of individuals provide them with a 1099 MISC (Miscellaneous Information) or 1099 NEC (Nonemployee Compensation) form. This form provides the IRS information about any income the person may have received from a company, other than related to a direct employment. This form is provided to independent contractors, self-employed individuals, or freelancers at the end of the year. In this classification any tax responsibility lies with the individual who received that income not from the company that paid it to the individual.
- In order to determine if a person should be a 1099 contractor, I have compiled a couple of questions you can consider asking yourself to help guide the determination. If you answer “Yes” to any or all of the questions, then you should be classifying the person as a 1099 contractor:
- Will this person be working in their own location?
- Will this person have autonomy of their work schedule?
- Will this person represent their own company?
- Will this person have control of their tasks and responsibilities?
- Will this person be using their own equipment?
- Will this person be responsible for obtaining the training and certifications needed to do their job?
Keep in mind that the above is not an all-inclusive list of questions or considerations in making your determination, however, it is intended to provide you some guidance on the proper way to classify an individual when you are in the process of introducing new members to the team.
At a high level, each of these classifications has its own set of responsibilities and financial obligations not only for the employer but also for the employee or independent contract, nevertheless, what’s important to remember is that the decision you make is based on a well thought out process and not just a quick response. Just because you might not want to have the burden of paying taxes or offering benefits, making all your workers 1099 might not be the right choice. Making an uneducated or not so well thought out decision can lead to serious consequences that could ultimately hit you bank account. I have seen many small businesses receive guidance that hiring all staff as a 1099 is appropriate, and it might well be the case sometimes if you can demonstrate a justification for it, but in my experience 9 times out of 10 having all staff members as 1099 sticks out as a sore thumb and becomes a red flag for auditors and government agencies.
The IRS, as well as the Department of Labor (DOL) have defined penalties, fines, and consequences for a misclassified employee. For example, the IRS has fines up to 41% of the individuals’ income if they are misclassified without any reasonable justification. The DOL has fines that can go back two to three years related to unpaid overtime wages, benefits costs, unpaid taxes and unpaid leave just to name a few. These are all costs that would need to be paid by the employer and depending on how many employees you have can lead to lots of money as most agencies calculate the fines and penalties by the amount of employees in an organization.
Now to answer the question on which to choose, the best tip I can give you is to side on the side of being cautious, if you are not completely convinced that the person would classify as an independent contractor (1099) based, at least, on the questions above then classify that individual as an employee (W-2). If you, or your HR team, need assistance with navigating through these classifications and understanding if you are protecting your company from this financial risk, please reach out to our team of professionals for a free consultation. We can help assess your potential risk, devise a plan to mitigate this risk and put the company back on track to protect your business.