The IRS has recently issued new interpretations of what how a worker qualifies as a 1099 employee. They have become concerned over the large number of employers that are shifting their tax payments on to their workers by claiming the workers are “independent contractors”. The fact of the matter is, most such workers are actually employees and should be paid as W-2 employees. It is the rare exception when a worker actually is an independent contractor.
Here are the three criteria that the IRS uses to determine who is an independent contractor:
- Behavioral control. If the employer determines when and where the employee has to work — they are an employee. If the employer determines what tools the employee has to use — they are an employee. If the employer determines who has to help the employee, where they have to purchase supplies or services or even what sequence the work must be performed in — they are an employee.
- Financial control. If the employer has financial control over the amount of income made by the employee — they are an employee. If the employer pays the employee a regular guaranteed wage for a period of time (by hour, week or month) — they are an employee. If the employer prohibits the employee from making their services available to others in the same market — they are an employee. If the employer controls the employee’s ability to make a profit or loss — they are an employee.
- Type of relationship. If the employer offers the employee benefits such as sick time, vacation time, insurance or a pension plan — they are an employee. If the employer expects the relationship will continue indefinitely rather than for a specific period or project — they are an employee. If the employer hires someone whose expertise is a key component of their regular work product (i.e. a law firm hiring an attorney, a construction firm hiring a carpenter, etc) — they are an employee.
It should be noted that the employee is considered an employee if ONE of these conditions is met. It is not necessary for the employer to meet all of the conditions for an employee to be considered a W-2 employee.
Given this information, it is clear that most persons that are currently considered “independent contractors” really aren’t. So what does that mean for the small business owner? It means that you should immediately contact your tax adviser or the IRS to determine if you are following the guidelines. It will also likely mean that you will have to start treating these persons as W-2 employees and withholding their taxes in an appropriate manner. Failure to do so will put you in the cross-hairs of the newly hired auditors who are working specifically to investigate the 1099 vs W-2 issue.
For further information, see IRS Publication 15-A: “Employer’s Supplemental Tax Guide”