What is a 1099 Employee? (Definition, Classification, and Laws)

1099 are self-employed workers, and are also referred to as independent contractors. They do not fall under the regular employment classification norms. They are temporary employees that will work for you and once they are done with their job, they are no longer considered as your employees anymore.

What is a 1099 Employee?

They are workers who work independently in any trade, business, or other professions. Their job is to provide services to all the public rather than working for a single client. These employees work under a written or verbal contract. The agreements should contain the details of the tasks to be performed by the employees to avoid any disputes. They are generally paid in terms of freelance basis. One thousand ninety-nine employees may work through a franchise, through the companies they own, or through an umbrella company. Some of the common types of 1099 employees are doctors, lawyers, veterinarians, accountants, etc. “1099 employees” has been derived from “1099 forms.” They get paid for their work without any additional benefits or tax reductions.

Related Reading : Exempt Employees | Non-Exempt Employees | Exempt vs. Non-Exempt Employees

Classification Rules for 1099 Workers

The IRS (Internal Revenue Service) has set the classification to identify the 1099 workers. An individual is only considered an independent worker if the payer has direct control over the work and not on how and when it will be done. To classify whether an employee is independent or not, some factors need to be considered:

• Behavioral Control: Does the employee have the freedom to work, or is the institution directing and controlling the employees’ work?
• Financial Control: Does the worker use their instruments and decide their expenses, or does the organization manage the employees’ financial details?
• Relationship of the Parties: Does the worker earn any benefits? Are there any chances that the parties will continue indefinitely? Are the services of the employees the major aspects of the institution?

Other Factors Include

• They are paid by the job or hour
• They set their own working time periods
• They are told the order of the work to be done by the company hired
• They receive training from the institution
• They work for more than one organization at once
• They invest in their own equipment and benefits
• They pay for their travel and business purposes
• They provide oral and written updates to the hiring company

Penalties for Misclassification

There will be penalties if an individual gets the classification wrong and identifies an independent worker as an employee. The individual may be held responsible for back employment taxes and substantial penalties with additional interest. These fines can be catastrophic for smaller businesses since they can add up. However, the positive side is that the Voluntary Classification Program allows the businesses that treat the employees as individual workers to reclassify and pay less. The criminal penalties may raise $1,000 for each misclassified worker, and a year of imprisonment can also be inflicted. Misclassification of regular employees with independent employees is considered a serious issue. It is a better idea to seek advice from the employment counsel to ensure the applicable laws. 

Pros and Cons of Being a 1099 Employees

It has its own benefits and drawbacks.

Pros

• Independent contractors are their boss: Independent contractors take charge of their work and the number of tasks. The 1099 employees can choose the number of works they are willing to do on a single day and manage their schedules according to their work timing. On the other hand, the more tasks they take up, the more they earn.
• Independent contractors have more flexibility when working: Independent contractors have flexible working hours than regular employees. There is no fixed timing for the 1099 employees like the other employees (eight hours). Although the independent contractors will have the deadlines set and their tasks, they can allocate their own time to finish them.
• Independent contractors earn more on average: Independent contractors tend to earn more on average than the other employees. They may earn up to 40% more on average, as the company does not need to pay for social security tax or provide for the benefits of the independent contractors. 

Cons

• Lack of job security: Most of the 1099 employees’ job arrangements are set up so that a distance is being created towards their workplace. Although it may be an advantage sometimes, if your source of income is being taken away without warning, it may raise questions for them to be independent. 
• Isolation: Working independently may seem enjoyable as it enhances the focus and creates a sense of motivation. But, working in isolation does not provide an additional advantage as the worker may feel lonely and not enjoy doing the task alone.

Paperwork Needed for a 1099 Employee

The IRS requires the independent contractors to fill up a form called “Form W-9” for Taxpayer Identification Number, and should be kept for four years after being hired. This form is used to request the right name and Taxpayer Identification Number (TIN). A TIN may be either be a Social Security Number (SSN) or an Employer Identification Number (EIN). If you pay the IC $600 or more for services provided throughout the year, the employee must be provided with “Form 1099-MISC” and sent within the 31st of January. 

A written contract is prepared by the attorney, in which the project and the results are being outlined. The contract should also mention:

• The client will not pay, withhold taxes or benefits
• The employees will use their instruments for their projects
• The client may cancel the contract if the employees’ works are not satisfactory or violate the terms of the agreement.

Non-employee Compensation on a 1099

Form 1099-NEC is one of the 1099 tax forms, including 1099-MISC for miscellaneous income, 1099-INT for interest income, and 1099-DIV for interest dividend and distribution income. The employees receive a 1099-NEC if they are paid more than $600 in non-employee compensation in one year. Independent contractors, freelancers, sole proprietors, and self-employed workers are the prime examples of non -employees who would receive a 1099-NEC. This form includes fees, commissions, prizes, or awards for the 1099 employees who completed their services. The form is also mandatory for those whose federal income tax has been on hold under backup withholding rules, nevertheless of the amount of payment.

The compensation is also mandatory for those who are not employees on a payroll, for business services, and to any individual, partnership, or estate. The IRS will inflict penalties for not filling the 1099-NEC on time and for incorrect information. The penalty rate starts from $50 per return and may rise to $550 per return. Some of the payments you need to pay on Form-1099 are Professional service to attorneys, fees paid from one professional to another, payments for services that include paying for parts or materials, and commissions to non-employee salespeople.

Bottom Line

Determining whether an employee is a regular employee or an independent employee must be taken into consideration. If anyone has a doubt regarding the status of an employee, an advice can be taken from the labor lawyer and certified professional accountant (CPA) to have a better understanding on the types of employees.

References

https://www.upcounsel.com/1099-employee
https://employersresource.com/business-compliance/what-is-a-1099-employee/
https://en.wikipedia.org/wiki/Independent_contracting_in_the_United_States
https://www.upcounsel.com/1099-contractor
https://www.letsdeel.com/blog/1099-employee
https://www.completepayrollsolutions.com/blog/who-is-a-1099-worker
https://www.innovativeemployeesolutions.com/wp-content/uploads/2015/06/1099-Classification-Guide.pdf
https://justworks.com/blog/consequences-misclassifying-workers-independent-contractors
https://www.letsdeel.com/blog/benefits-of-being-an-independent-contractor
https://onebiteblog.com/1099-or-w2-independent-contractor-vs-employee-pros-and-cons/
https://www.zenefits.com/workest/what-forms-do-you-need-to-hire-an-independent-contractor/
https://www.investopedia.com/form-1099-nec-nonemployee-compensation-definition-5181240
https://www.wendroffcpa.com/irs-reintroduces-form-1099-nec-for-non-employees/
https://www.thebalancesmb.com/what-is-form-1099-nec-for-nonemployee-payments-4781974
https://www.lendingtree.com/business/1099-vs-w-2-employee/