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Worker classification: key differences between 1099 contractors and employees

Are you misclassifying your workers? There’s a big difference between 1099 contractors and employees. A classification mistake could result in expensive lawsuits and penalties.

The Difference Between 1099 Contractors and Employees

1099 workers are independent contractors. They are essentially self-employed individuals who provide services to a company. Employees, on the other hand, work directly for the company.

Many of the laws that govern how companies treat employees do not apply to independent contractors. For example, Fair Labor Standards Act (FLSA) wage and hour laws involving overtime pay and minimum wage don’t apply to independent contractors. Affordable Care Act (ACA) requirements for employer-sponsored health care don’t apply to independent contractors either, and many businesses don’t offer any benefits to these workers.

The tax situation is different, too. Companies are not responsible for payroll taxes for independent contractors. Independent contractors have to carry the full tax burden themselves.

How to Determine the Right Classification

The U.S. Department of Labor (DOL) warns that, for the purposes of the FLSA, a worker cannot be classified as an independent contractor simply because the company and worker agree to the arrangement. Instead, the classification must be consistent with the law.

According to the IRS, “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, not what will be done and how it will be done.” Companies should consider their behavioral control, financial control and relationship with the workers.

However, state law also matters. California recently enacted a law, AB 5, that creates strict requirements for companies trying to classify workers as independent contractors. This law expands the California Supreme Court’s ruling on a case involving Dynamex Operations West, Inc., and it states that workers can only be classified as independent contractors if they meet a strict three-part test called the ABC test.

Classification laws are currently hotly debated, and new laws may be on the horizon. Notably, the DOL recently released a proposal to change its interpretation of independent contractor status under the FLSA.

Should you offer benefits to 1099 workers?

As mentioned, the ACA’s requirements for employer-based coverage don’t apply to independent contractors, and companies have historically decided against offering these workers benefits. However, this may be changing.

As companies try to win the talent war, offering benefits seems like a possible way to attract skilled workers. Benefits may also help prevent problems and reduce stress, resulting in a happier, more productive workforce. According to HR Dive, SurveyMonkey announced in 2018 that it would offer benefits to its contract workers.

Extending benefits to independent contractors may be complicated, however. It’s important to make sure you’re following the rules of the group health plan as well as all relevant laws, including state laws, for benefits.

Should employers pay 1099 workers through payroll?

Another question that business owners might have regarding independent contractors is how to pay them.

Before starting work, employees should fill out a W-4 form, whereas contractors should fill out a W-9 form. When the tax year has finished, employees will receive W-2s, whereas independent contractors will receive Form 1099 (this is why they’re sometimes called 1099 workers).

Employees are paid through payroll, and payroll taxes must be taken out. Some payroll software programs may support contractor payments as well, and you may find it convenient to have all your labor payments tracked in one system, but it’s highly recommended that employers pay contractors through invoices instead of through payroll. The DOL looks at this to determine whether contractors should be classified as employees.

Need guidance on how to classify and compensate your team members? Contact our HR Services.

Not sure where to start? Talk to someone who wants to listen.

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