Independent contractors make up a large group in the workforce. In fact, a lot of people call the post-recession economy the 1099, or gig, economy.
You’ve probably hired a few of these independent 1099 contractors yourself to work on certain projects. You obtained an written agreement from the worker acknowledging that s/he is an independent contractor (commonly referred to as a 1099 worker/employee).
Going forward, be very careful before you repeat this.
Somewhere in the distant past, you heard from someone (not a lawyer of course) that this is an ideal way to classify workers because it saves the business money. 1099 employees don’t have to paid overtime. Since they aren’t on payroll, you can keep payroll and other taxes, including the unemployment tax, under control. They can’t collect workers’ compensation so you get a break on premiums as well.
Moreover, everyone else in your industry is doing this, so how could it be wrong? How could there be any harm to anyone?
The 1099 Contractor Shoe Drops: Misclassified Employees
More and more, I’m seeing what happens to employers who have been told they have misclassified their 1099 contractors.
Let me share with you a typical scenario. An employer tells me one about an independent contractor he or she hired who was was slacking on the job. After several attempts to correct the problem, the employer ended the contract. The contractor took a dim view of this and quite naturally looks to see how to make life more difficult for the former client. Here are some things contractors have done:
- Filed an unemployment claim with the Department of Economic Security, which triggered an expensive and disruptive audit of the business. DES often decides that a 1099 worker should never have been considered an independent contractor. Others on the payroll are also found to be misclassified. This leaves the employer paying a lot of fees and penalties.
- Informed the IRS that s/he and others were misclassified by the employer. The employer is often held liable for underpaying payroll taxes and not withholding the proper amount of social security contributions from paychecks. Add in interest and penalties, and there’s quite a lot of money flying the wrong.
- Applied for workers’ compensation benefits through the Special Fund of the Arizona Industrial Commission. The Commission then pursued the employer for reimbursement of benefits paid, and adds penalties as well.
General Advice to Employers on Classifying Independent Contractors
There is no bright-line rule on how to classify workers as W2 (wage) employees or 1099 contractors. The most important factor hinges on the extent of control the employer has over the worker.
This leaves a lot of businesses at risk for potential penalties for misclassification. The IRS uses a 20-question test to determine if workers are independent contractors or employees. The Arizona Registrar of Contractors (ROC) also has a questionnaire to help employers determine the proper way to classify employees that asks about training, supervisions, ownership of tools, and whether the contractor is licensed with ROC.
Employers need to understand that they cannot classify, or re-classify, employees as independent contractors to reduce operating expenses. They should be very certain that the worker is truly an independent contractor. Misclassifying employees is a costly mistake. Taking the proper preventative measures can save your company a great deal of money and negative exposure in the long run.
Don’t guess employee classification. If you have any doubts, contact my office for a consultation to help you assess this matter.