What is a 1099 employee? They are self-employed workers, also called independent contractors. Form 1099 reports the income that independent contractors receive throughout the year to the IRS for tax purposes. This form replaces the need for a W-2 and indicates that they are not an employee, no employer is responsible for paying FICA taxes or withholding income tax, and the independent contractor is responsible for paying Self-Employment Taxes.
Common Types of 1099 Employees
1099 “employees” are generally individuals who are in an independent trade, business, or profession in which they offer their services to the general public (not just a single customer or employer), including:
- Real Estate Agents
However, they aren’t always easy to classify, and the factors that determine the classification can feel subjective.
“The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.” – IRS.gov, Independent Contractor Defined
Risks of Using a 1099 Employee
When it comes to independent contractors, employers are not expected to withhold income taxes, pay FICA taxes, and in some cases, pay any premiums for workers’ comp or unemployment insurance. On the surface, using an independent contractor sounds simpler and more attractive than having a W-2 employee.
Should you hire independent contractors? Of course! If that’s what best defines your relationship with the employee and makes the most sense for the job that needs done. Just be care, and consider the risks:
- Worksite injuries. Independent contractors should have their own workers’ compensation coverage to protect your business from liability.
- Misclassifications. While your 1099 employee may begin as an independent contractor, their relationship to your company can change over time. Review the contractor’s status every 6 to 12 months to avoid becoming an employer by accident.
- Penalties and fines. Misclassifications put your business at high risk for multiple penalties, fines, and back-taxes.
1099 vs. W-2 Employee Tests
Generally, your workers will not qualify as 1099 employees and will be classified as regular employees in the eyes of the IRS and the state. But if you wish to hire independent contractors, these are the guidelines the IRS and (some) states uses to determine employee classification types.
FLSA 6 Prong Test
- Extent of work performed by the independent contractor.
- Workers managerial skills affect his/her opportunity for profit or loss of the company.
- Does the worker invest in facilities/equipment?
- What is the worker’s skill and initiative?
- Permanency of the relationship. (i.e. Do you work with them every day?)
- Nature and degree of control by the employer.
IRS 3 Prong Test (Darden Factors)
- Behavioral control of the organization over the independent contractor.
- Financial control (providing tools, uniforms, vehicle).
- Relationship of the parties.
Regulations may vary from state to state, and your classification must include consideration of applicable state law—for instance, California’s ABC test is more demanding:
- The employer must prove, without any doubt, that they do not exercise control over the worker’s ability to perform a certain task.
- The worker is performing a task or job that is outside the functions of the business in question.
- The worker has an established trade or a business that they customarily engage in.
A 1099 employee is an independent contractor and there may be some benefits that make it look like a good option, but we want to caution employers to cross their t’s and dot their i’s. Misclassification hurts! Don’t forget to check out our full ebook on 1099 vs. W-2s below, especially if you’re considering hiring a 1099 employee.