Recently we were completing an application for insurance in which the insurer posed the following question: “Does the Company make use of independent contractors or non-employee labor? If ‘Yes,’ provide number of such workers used in last 12 months.” Our firm, as a business, uses several companies to provide services. We, for example, engage a vendor to maintain our technology. We use an outside company to shred documents so that discarded items do not reveal confidential information. As a law firm, we regularly engage, on behalf of clients, court reporters to record deposition testimony.
It did not seem the insurer’s question was really asking about our arrangements with such service providers. Instead, it appears to be directed at a specific type of relationship.
Occasionally, you will hear an individual described as a “1099 employee.” What normally is meant by this is that an arrangement has been reached in which the individual is performing work as an independent contractor. Thus, the various laws regulating employees do not apply. Independent contractors receive a Form 1099 stating the amount they have been paid during the year; employees receive a W-2. Thus, if a person is appropriately given a Form 1099, he or she is not an employee.
There are several perceived advantages for a business to attempt to classify someone as an independent contractor instead of as an employee. For example, a business does not have to withhold taxes, pay FICA withholding, have worker’s compensation insurance or pay unemployment for independent contractors. Laws protecting against discrimination are generally tailored to employees. The law regarding responsibility of a business for damages caused by an employee is different than for an independent contractor.
In addition, the recent federal tax changes may have created a reason for the person providing services to want to be an independent contractor. The pass through deduction may create a lower total tax burden for an independent contractor.
However, while a party providing services and the business receiving them are free to negotiate many aspects of the arrangement, they are not entitled to simply agree that someone is an independent contractor. Instead, others who have an interest in the classification have a say. This includes, the governmental agencies charge to enforce various laws and collect revenue.
There are several consequences if a business mis-classifies a person as an independent contractor. For example, governments may seek interest and penalties for unpaid taxes. In the event a worker is injured an employer may be without worker’s compensation insurance to cover a claim.
Like many situations, there are shades of gray involved in determining whether someone is an employee or independent contractor. To complicate matters, the definitions used to determine whether someone is an independent contractor or employee are not uniform. The IRS recognizes five categories: independent contractor, common law employee, statutory employee, statutory nonemployee and government worker.
In general, the various tests used focus on a few similar factors. One is behavioral, asking whether the business or the worker controls the way the work is done. Courts and agencies also look at financial factors. For example, the questions of whether the worker pays his or her own expenses, and whether the worker will recognize a profit or loss based on a good or bad decision, are scrutinized. There are also relationship factors, such as whether the worker has other clients. Along these lines, a frequent question is whether the services are part of the regular business of the company. A person hired by an accounting firm to do taxes for clients will be looked a differently than an individual hired by the same firm to clean the offices.
It may be beneficial in many cases to detail the relationship, especially in close cases. For example, an agreement may note that the person providing services is free to offer them to others at the same time, is able to determine how to perform the tasks and will be utilizing his or her own equipment. The bottom line is that even if a business and worker agree to the classification, it is not binding on the government or courts. Because of the issues that may arise with mis-classification, businesses need to be careful before classifying a service provider as an independent contractor. In any case, under no circumstances, should anyone be called “a 1099 employee.”