The distinction between a 1099 independent contractor and a W-2 employee is important, as this classification affects federal income tax, Social Security and Medicare taxes, as well as impacts eligibility for Medicare benefits.
It is important that business owners correctly determine whether individuals are employees or self-employed. If a company misclassifies a worker as an independent contractor who is actually an employee, the company could be liable for missing employment taxes, interest and penalties. Additionally, the employee may be entitled to past benefits.
Business owners generally must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment taxes on wages paid to an employee. An employer also must provide a Form W-2 to an employee. No similar withholdings or taxes are required for payments to independent contractors. Instead, independent contractors are required to pay their own income and self-employment taxes and may be able to deduct business expenses. The company may be required to provide an independent contractor a Form 1099-MISC.
How do I know if an individual is an employee or independent contractor?
Before a company can determine how to treat payments for services, it must determine the business relationship between itself and the individual performing the services. Relevant information in making this determination includes any information that shows the degree of control and independence the individual has when performing services.
An individual’s label or position title is not determinative, and instead, it’s necessary to look at the totality of the relationship. There is no magic formula for determining a worker’s employment status, but there are factors that help guide an assessment. There are generally three primary factors considered when determining if an individual is an independent contractor or an employee:
- Behavioral Control: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- If a company gives extensive instructions on how work should be done, that indicates the worker is more likely an employee. Instructions may include how, when and where to complete work; what tools or equipment must be used; what assistants need to be hired to help with any work, and where to purchase supplies and other services.
- If a worker receives extensive training or significant tools, materials and other equipment from the company, the worker is more likely an employee.
- If a worker has set hours of work, established by the company, the worker is more likely an employee.
- Work performed on the premises of the company for whom the services are performed suggests the worker is an employee.
- Financial Control: Are the business aspects of the worker’s job controlled by the company?
- If a worker has a significant investment in his work, he is more likely an independent contractor.
- If the worker is not reimbursed for some or all business expenses, he is more likely an independent contractor.
- If a worker is able to realize a profit or incur a loss, he is more likely an independent contractor.
- Relationship of the Parties: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
- If a worker receives benefits, he is more likely an employee.
- If a contract exists, that might be an indication that the worker is more likely an independent contractor.
- If a company has a right to discharge the worker or the worker as the right to quit work at any time without incurring liability, he is likely an employee.
If a company is not able to accurately determine whether a worker is an independent contractor or an employee, a Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding can be filed with the IRS. The Form SS-8 asks multiple questions about each category (behavioral control, financial control and relationship type) to get a full picture of the degree of control and independence the worker has. The IRS will make a determination on the worker’s status.
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The factors listed above are not all-inclusive. There are other factors to be considered when determining the employment status of an individual.
If your business is unsure of the employment status of individuals performing services, attorneys at General Counsel PC can help you make an accurate determination and avoid having to ask the IRS, or worse, face penalties for misclassifications later. Our attorneys are specialized in labor and employment law and have experience working with business owners across Virginia. Call General Counsel PC at 703-556-0411 today to see how we can help you.