Highlights
- 1099 employees are self-employed professionals (also known as independent contractors) hired to perform specific tasks for your business.
- For employers, hiring 1099 contractors might be a good strategy to reduce labor costs and gain flexibility in staffing.
- At Employers Resource, we provide PEO services to help businesses stay compliant and handle HR-related tasks. Get a custom quote today!
What is a 1099 employee? According to the U.S. employment laws, 1099 employees are self-employed workers, also called independent contractors.
Unlike traditional W-2 employees, 1099 workers are self-employed individuals who provide services to a company on a contract basis. This classification carries significant implications for both the business and the contractor, including tax responsibilities, benefits, and legal liabilities. By understanding the pros and cons of hiring 1099 workers, businesses can make informed decisions about their workforce and potential cost-saving measures.
So, let’s dive in!
How Does 1099 Employment Work?
1099 employment is a contractual relationship between a business and an independent contractor. The business pays the contractor for services rendered, typically based on a flat fee, hourly rate, or project completion.
The reason self-employed workers are often referred to as “1099 employees” is because businesses use Form 1099-MISC to report payments made to these contractors to the IRS. This form replaces the need for a W-2 and indicates that they are not an employee, no employer is responsible for paying FICA taxes or withholding income tax, and the independent contractor is responsible for paying Self-Employment Taxes (Social Security and Medicare).
Contractors don’t receive traditional employee benefits like health insurance, paid time off, or retirement contributions. Additionally, contractors are not subject to the same level of supervision as employees, and have more control over their work schedules, methods, and tools.
Download the Complete Guide: W-2 vs 1099 Employees
Common Types of 1099 Employees
1099 “employees” are generally individuals who are in an independent trade, business, or profession in which they offer their services to the public (not just a single customer or employer), including:
- Doctors
- Dentists
- Veterinarians
- Real Estate Agents
- Lawyers
- Accountants
- Contractors
However, they aren’t always easy to classify, and the factors that determine the classification can feel subjective.
“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 and not what will be done and how it will be done.” – IRS.gov, Independent Contractor Defined
Pros of Hiring a 1099 Employee
Hiring 1099 contractors offers several advantages for businesses:
- Cost savings. One of the primary benefits is cost reduction. Businesses avoid expenses associated with employee benefits such as health insurance, paid time off, and retirement contributions. Additionally, there are no payroll taxes to withhold or match.
- Flexibility and scalability. 1099 workers provide flexibility as businesses can easily adjust their workforce based on project needs. When workload increases, more contractors can be brought on, and when it decreases, the workforce can be scaled back.
- Access to specialized skills: Businesses can tap into a wider pool of talent by hiring 1099 contractors. This allows them to access specialized skills and expertise without the commitment of full-time employment.
- Reduced administrative burden: Managing 1099 workers typically involves less administrative work compared to W-2 employees. Payroll processing, tax withholdings, and benefits administration are eliminated or simplified.
Risks of Hiring a 1099 Employee
When it comes to independent contractors, employers are not expected to withhold income taxes, pay FICA taxes, and in some cases, pay any premiums for workers’ comp or unemployment insurance. On the surface, using an independent contractor sounds simpler and more attractive than having a W-2 employee.
Should you hire independent contractors? Of course! Just be sure that’s what best defines your relationship with the worker and makes the most sense for the work that needs to be done.
While hiring 1099 contractors offers certain advantages, it also comes with a few risks that you must carefully consider:
- Misclassification. The relationship between a business and a contractor can evolve over time. What began as an independent contractor arrangement might gradually take on characteristics of an employer-employee relationship. It’s crucial to regularly assess the nature of the working relationship to ensure continued compliance with labor laws and avoid misclassification. Periodic reviews, ideally every 6 to 12 months, can help prevent accidental misclassification.
- Liability Issues. Unlike employees, 1099 contractors are generally not covered by workers’ compensation insurance. If a contractor is injured on the job, the business could be held liable for damages.
- Lack of employee benefits: Without offering benefits, businesses may struggle to attract and retain top talent, especially for long-term projects.
1099 vs. W-2 Employee Tests
Generally, your workers will not qualify as 1099 employees and will be classified as regular employees in the eyes of the IRS and the state. But if you wish to hire independent contractors, these are the guidelines the IRS and some states use to determine employee classification types.
FLSA 6 Prong Test
- Extent of work performed by the independent contractor.
- The company’s opportunity for profit or loss based on the worker’s managerial skills.
- Does the worker invest in the company’s facilities/equipment?
- What is the worker’s skill and initiative?
- Permanency of the relationship. (i.e. Do they work exclusively with you every day?)
- Nature and degree of control by the employer.
IRS 3 Prong Test (Darden Factors)
- Behavioral control of the organization over the independent contractor.
- Financial control (providing tools, uniforms, vehicle).
- Relationship of the parties.
State Requirements
Regulations may vary from state to state, and your classification must include consideration of applicable state law—for instance, California’s ABC test is more demanding:
- The employer must prove, without any doubt, that they do not exercise control over the worker’s ability to perform a certain task.
- The worker is performing a task or job outside the business functions in question.
- The worker has an established trade or a business that they customarily engage in.
A 1099 employee is an independent contractor and there may be some benefits that make it look like a good option, but we want to caution employers to cross their t’s and dot their i’s.
Misclassification hurts! If you’re considering hiring a 1099 employee, don’t forget to check out our full e-book on 1099 vs. W-2s.
Mitigate Risks When Hiring 1099 Contractors
Hiring 1099 contractors can be a valuable strategy for businesses, offering cost savings, flexibility, and access to specialized skills. However, it’s crucial to understand the risks involved, particularly misclassification, which can lead to significant legal and financial penalties.
Before deciding whether to hire W-2 employees or 1099 contractors, consider the project scope, required skill set, and your business’s long-term goals. Additionally, staying informed about worker classification guidelines is essential.
However, we know that managing a workforce, especially one that includes both W-2 employees and 1099 contractors, can be complex. This is where a Professional Employer Organization (PEO) like Employers Resource can be your trusted partner.
Our comprehensive PEO services cover everything from HR compliance to payroll. Let our HR experts navigate complex issues like government compliance, new hire paperwork, and employer liability, while you focus on growing your business.
Ready to simplify 1099 management? Contact us today for expert guidance.
