As a small business owner, bringing in any new employee is a big deal. Each new hire means additional paperwork, hidden payroll costs, and tax withholding requirements. All of that extra work is going to stretch your bookkeeper thinner than they already are, especially if that bookkeeper happens to be you.
Many small business owners believe they can just hire remote workers to handle back-office tasks and use them as 1099 contractors. After all, aren’t all remote employees automatically under a 1099 status? Unfortunately, this isn’t the case.
Here’s what you need to know to stay compliant amid today’s rising wage and remote work trends.
1099 Contractors vs. W2 Employees
The Internal Revenue Service offers ample guidance regarding worker classification and, specifically, the difference between 1099 vs. W2. But the IRS website also uses a lot of “legalese” that can be difficult to sort through.
The IRS developed a 20-Factor Test to determine whether a worker is an employee or an independent contractor based on the level of control the company has over how the work is performed. It evaluates factors such as the degree of instruction, training, business integration, personal services, control of assistants, continuity of relationship, flexibility of schedule, and methods of payment. Download it here >
Take a closer look at this more straightforward breakdown of these key classifications.
1099 Contractors
Generally, 1099 contractors are self-employed and offer their services to the public. They operate their own business and have control over how they perform their work. Contractors usually provide their own tools and resources. They are paid per project or on a freelance basis.
Contractors also have to pay their own taxes, including self-employment tax. For example, suppose that you hire a freelancer to revamp your website. You agree on an hourly rate, and they will work for you for six months. However, it’s a one-off partnership to complete a single project. In most instances, this person would be considered an independent contractor.
W2 Employees
W2 employees work under your direction. You’ll typically provide them with the tools and resources they need to carry out the responsibilities you assign. W2 workers also receive a regular wage or salary, and you are responsible for withholding taxes from their paychecks.
A W2 worker is entitled to certain benefits, which may include health insurance, retirement plans, unemployment insurance and workers’ compensation. You also have to pay these employees a minimum wage in accordance with the state law where the worker resides.
Why You’ve Got to Get Employee Classifications Right
If you misclassify a worker, you could face major legal and financial consequences at the state and federal levels. Some potential penalties include back taxes and fines. If you violated a W2 worker’s rights by misclassifying them as a contractor, they may also sue you.
For example, perhaps you hired a graphic designer who works from home. You classified them as a 1099 contractor but dictated their work schedule, directly oversaw their work, and supplied the resources necessary to carry out their responsibilities. Based on these details, they should have been classified as a W2 employee.
If you underpaid them during the time they worked for you, you may owe them back pay, including overtime pay. You could also face fines. But that’s not all; you will also have to calculate the amount of taxes that should have been withheld and pay the IRS.
Key Differences Between Remote Work and 1099 Status
One prevalent myth is that remote workers automatically qualify as 1099 contractors. However, that’s simply not the case. The location of the work doesn’t determine whether someone should receive a 1099 or W2. The IRS considers the nature of the relationship and the degree of control that you have over that person’s work.
Here are some signs that a person is a W2 employee:
- You dictate when they work, such as 9 to 5
- You provide resources and supplies
- They earn an hourly wage or fixed salary
- You provide detailed directions regarding what they do
A 1099 contractor has similar but distinct traits.
Some indicators that someone is a 1099 contractor include:
- They provide their own supplies and tools
- They set their own hours
- They are paid by the project or milestone
- Pay fluctuates
You can maintain an ongoing partnership with a contractor. You can also set project deadlines. For example, if you hire a freelancer to create five new blogs for your website, you might set a deadline of seven days and agree on a fixed price.
Even though you are providing some direction of when the contractor works — during the week before the deadline — you aren’t setting their hours or prioritizing their tasks. They could complete all content on their terms, provided they meet your deadline.
Need Help Managing Your Workforce? Focus HR Has You Covered
Use these simple checklists to evaluate worker relationships and avoid misclassifications. Doing so will promote payroll tax compliance and save you any headaches associated with worker classification violations.
Even with the right checklists, however, managing a small business can be tough. But keeping up with payroll and HR doesn’t have to be. Focus HR can simplify worker management so that you can devote your energy toward growing your business. Contact our team to request a consultation for your small business today.
