As human resource consultants, we are often confronted with companies classifying and paying individuals as “1099 employees.” Many times it’s for convenience — either for the company or for the working individual. If neither party has an issue with it, does that mean it's legal? In a nutshell: no. The bottom line is that there is no such thing as a “1099 employee.” Only independent contractors receive a 1099 classification, while employees get a W-2. When someone is an employee, the company must withhold (and pay) taxes, and cover them with workers’ compensation and unemployment insurance. Consequences for employers who fail to do this correctly come in the form of back taxes, penalties, interest, and fines.
Both the Department of Labor and the IRS (the Feds) have an opinion about reporting earnings on a 1099 rather than a W-2 form. The IRS looks at it from a tax perspective while the Department of Labor looks at it from an employment and pay perspective. Additionally, many states have specific statutes regarding the independent contractor classification.
Employee Versus Independent Contractor
What if you decide to call your workers independent contractors, then it’s okay, right? Unless the individuals meet specific tests outlined in the law, you cannot arbitrarily designate them as independent contractors. If you have a whole department designated as independent contractors, you are more than likely in violation.
There are several factors used to determine the status of an individual. Key elements include:
Who is responsible for directing the work
How the individual is paid
Who schedules the hours
The chance for financial loss to the individual
Who supplies the work tools
If the individual relies solely on your company for income
If the company directs the work, or states how the work must be accomplished, if the pay is by the hour, week or month, and/or the company holds the individual to a specific schedule saying when to report to work and for how long, that individual is most likely an employee and not an independent contractor. Additionally, the IRS looks at behavior control, financial control, and the over-all relationship.
In Tennessee, federal law occasionally governs; however, utilizing state employment law most often answers the question. Worker’s compensation law looks at control of work, scheduling of work hours, ability to hire helpers, and the ability to offer same or similar services to others. Under unemployment compensation law the individual must be free from control and direction in performing the service to qualify as an independent contractor, along with performing the service outside the usual course of business for the organization . Also the individual must be customarily engaged independently in a trade occupation or business performing that service.
The Bottom Line
In conclusion, only an independent contractor, performing work outside of your normal operations, with his/her own business, utilizing their own tools, and in control of the direction of work, should be paid as a “1099.” If you have any questions about legally classifying the people who work for you, contact us for help.