As a business owner, chances are that you have had to decide whether to classify someone as an independent contractor (1099) or an employee (W-2). Or perhaps you have workers who fall into both categories, and you don’t remember how you made the decision to go one way or the other. Or maybe this is an issue you don’t think about at all! Why should you care, anyway? If it seems that all of your workers are happy with the way they are classified, how would anyone find out about a problem, even if you did have one?
Issues with classification arise commonly in two scenarios: (1) You are audited by the IRS or Department of Labor, and classification issues come to light; or (2) The worker raises a concern and/or files for unemployment (which can also trigger an audit).
In any of these scenarios, a red flag is thrown up that something was wrong with worker classification. You as a business owner can then become liable for back taxes, paying back wages (like overtime) to the worker, back benefits, and sometimes even fines or penalties.
Get out ahead of classification issues before they get the better of you! Here are five signs your independent contractor is actually an employee:
1. Duties: Your 1099 is doing similar work to your employees’ work.
Contractors ideally should be supplementing the normal work of your business or doing work that you would otherwise refer out. If your contractor’s job duties are virtually indistinguishable from the work your employees are doing, chances are you’ve got a classification issue.
2. Payment: Your 1099 is hourly or salaried.
A real contractor should have some ability to experience profit or loss, which usually means they are paid per project, or on a commission basis. If you are paying your contractor on the normal payroll schedule, just like you pay all of your other employees, they may be misclassified.
3. Method: You care about the way your 1099 does their work.
Do you have opinions about the way your contractor’s work is performed, or are you only concerned with the end result? If you expect your contractor to follow your in-house procedures, SOPs, or other processes that you apply to your staff, then it’s a sign they may actually be an employee.
While it’s fine to have some input on the work being completed, you should not be controlling day-to-day tasks. Think of hiring a cleaning company to clean your business. You probably care that they are cleaning once per week, and using a certain standard of product, but you likely do not care who from the company is performing the cleaning, and you likely do not care what order they clean your rooms — you only care that the office is cleaned once per week. Such should be the case for a properly classified contractor.
4. Schedule: Your 1099 is regularly and consistently working with you.
Another sign of misclassification is an ongoing or indefinite relationship with your contractor. Most of the time, a contractor is going to be engaged for a limited project, or for a finite period of time. If your contractor’s schedule is ongoing, consistent, regular, and/or indefinite, you may have an employee on your hands.
5. Benefits: Your 1099 gets paid-time-off.
Contractors typically do not get the benefits of regular employment: paid time off, vacation, sick leave, leaves of absence, health insurance, or retirement benefits. Similarly, contractors typically cover their own expenses and buy their own tools. Providing these benefits to your contractor points to a misclassification issue.
As the IRS clearly states, there is no one factor or magic number that makes a worker a contractor or an employee. One big thing to keep in mind is that the employee classification is the default classification. There are no fines or penalties for opting to classify someone as an employee. Your risk comes from making the choice to classify someone as a contractor. It’s important to work with a professional to perform an individual analysis of each worker before issuing a 1099 to them.
If you would like help navigating questions like these, contact Terch & Associates today!