Due to the COVID-19 global pandemic, businesses all around the globe begin seeking a more flexible and friendlier working environment, each passing day. With the increase of freelance work, there has also been a rising confusion regarding the benefits and tax implications of employing ‘1099 employees’ (a popular name for independent contractors)

In favor of the process, many companies are tending to select Contractor Management Outsourcing to begin engaging 1099 employees/independent contractors much easily.

Before employing a 1099 employee/independent contractor, it is essential to recognize the laws and rules governing their employment. This makes sure that that you aren’t taken by surprise by unexpected tax implications or misclassification penalties along the way.

What is a 1099 employee?

A ‘1099 employee’ is technically an independent contractor (sometimes called a freelance), who is usually employed for a fixed time period, or on an ‘ad hoc’ basis. Individuals hired to create social media posts, write website content, edit photos and film, or design a logo, are a few common examples. 1099 employees are usually 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 is not eligible for a benefits package or a salary. Moreover, they are not subject to workers compensation and certain labor laws. A 1099 employee/independent contractor are usually entrepreneurs, and often works for multiple clients simultaneously.

Although the terminology can be a bit misleading, it is important to categorize a 1099 employee/independent contractor correctly in order to avoid penalties and fines associated with misclassification (more on this below). Therefore, we discuss here some of the key questions to ask when dealing with 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 organization should ask three questions:

1.     Is the individual’s job controlled by the business?

2.     Is the individual’s salary and reimbursement of his/her expenses and supplies controlled by the business?

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 focuses on controlling the behavior of the individual and how the project is completed. A W-2 employee is often required to work during fixed hours, at a given place or is trained in a particular way by the employer. However, An independent contractor, often works according to their own schedule and is already proficient in their field without the need of prfound training.

Financial Control

The second question focuses on 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. Most W-2 employees are reimbursed for additional expenses that are essential for their work such as gas mileage, internet and office supplies. On the other hand, an independent contractor is often in charge of 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 addresses the general nature of the employment relationship via evidence such as written contracts and benefit agreements. A written contract doesn’t necessarily mean that someone is a W-2 employee. However, a contract with a salary and expounded benefits proves that an employee is more than a mere contractor working on a temporary basis. A 1099 employee could still have a contract with the company, but it will usually dictate that the individual is not eligible to any of the benefits of an employee.

What are the 1099 employee rules?

The most important rule to follow is that any business need be perfectly certain that an individual is an independent contractor before treating them as such for tax purposes. If the independent contractor confronts their status as an independent contractor and the IRS agrees, a company might have to deal with enormous fines and penalties from being unable to pay the appropriate taxes and benefits. This makes it extraordinarily important to classify a 1099 employee accurately.

What paperwork is needed for a 1099 employee?

When tax season comes around, a business which has employed independent contractors needs to submit 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 motivated the IRS to create a new form solely for independent contractors, the 1099-NEC.

Employers must get personal identifying information from their independent contractor initially, including their address and tax identification number. Utilizing 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.

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