01 Oct1099 ‘Subcontractor’ vs. W2 ‘Employee’
As someone who specializes in commercial insurance and risks, one of the most common statements I hear clients make is that they don’t have any employees, they only use ‘subcontractors’. They assume that by paying people on a 1099-basis that they are being smart and hiring ‘independent contractors’; thereby avoiding the many entanglements that may arise from hiring someone as a true W2 employee.
To get right to the point, this is WRONG WRONG WRONG. Is that clear enough?
Your misinterpretation of a worker’s real employment status can cost you thousands of dollars.
As a business owner or investor, you probably hire people on a fairly regular basis either for part-time or seasonal assistance or as full time help, and like many small employers, you want to avoid paying payroll taxes, you don’t want the ‘responsibility’ of an ‘employee’ and you choose to pay on a 1099 basis and then call these workers ‘subcontractors’ – but are they really – or do you simply assume they are ‘subcontractors’ because you don’t pay their taxes? What’s the real difference between a W2-employee and someone paid on a ‘1099’ basis? What happens is this ‘subcontractor’ becomes ill or gets injured related to the work? Can he or she sue you for wrongful termination or discrimination? Do you need worker’s compensation? Are they entitled to any benefits you offer and can they come back against you for not providing them as you do to your other W2 staff?
To put a common myth to rest at the start, you need to understand that paying someone on a 1099-basis and making them responsible for their own employment taxes each year is does not automatically make them a subcontractor or independent contractor. The ‘1099’ versus W2 is only a concern for the IRS in regards to which party is responsible for paying payroll tax. That’s it. Either they pay their payroll taxes or you do. In the event of an injury or litigation, it’s the Department of Labor that determines employment status based on some established criteria listed later in this article.
Here are a few things every business owner should know about hiring people as independent contractors versus hiring them as employees.
1. The IRS uses three characteristics to determine the relationship between businesses and workers:
- Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.
- Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job.
- Type of Relationship factor relates to how the workers and the business owner perceive their relationship.
2. If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.
3. If you can direct or control only the result of the work done — and not the means and methods of accomplishing the result — then your workers are probably independent contractors.
4. Employers who misclassify workers as independent contractors can end up with substantial tax bills. Additionally, they can face penalties for failing to pay employment taxes and for failing to file required tax forms.
COMMON INSURANCE-RELATED QUESTIONS
Should I purchase worker’s compensation insurance? I only use subcontractors.
Probably. As mentioned above, your assumption of what a subcontractor is versus the reality of his or her employment status are probably two different things. If someone you are paying on a 1099-basis becomes ill or sustains an injury related to his or her employment and the employment status is determined to be as an employee, you are legally responsible for all medical costs, lost wages, future lost wages, etc, regardless of who is paying the employment taxes.
How does the money I pay 1099 employees affect my general liability premium?
If you are paying your ‘employees’ on a 1099 basis and you have reported them as ‘subcontractor payroll’ on your general liability insurance, your premium is probably higher than it should be as subcontractors are rated higher for liability premium purposes. Reclassifying them as ‘employee payroll’ (assuming this is the case) should reduce your premium some.
VIEW THESE OTHER RESOURCES
IRS Publication 1779 – Independent Contractor or Employee