Employment Classifications: 1099 or W-2
Okay, you’ve heard from several people, “you’d better be sure that your employees are classified correctly. There are some nasty fines for companies that do it wrong.” So, you go online and start a Google search on “W2 or 1099”.
Yeesh! How many opinions can there be? I just needed to find out if my (expletive) workers should be W2 or 1099!!
Now let me help out here. Ready? Wait, put on your thinking cap because I’m not going to do that part for you.
FIRST: Identify just one position and list EVERY SINGLE task/job/project someone in this position will do for your company. Pay special attention if the work performed is “key” to business operations.
SECOND: List a name for each task/job/project to show who is responsible for, or directing, the work being performed. Pay special attention to times when the work performed is based on a “judgement call” by the worker and if he/she needs special understanding to solve such a question.
THIRD: Analyze how expenses are compensated and who provides supplies. Is the worker reimbursed for expenses related to the work performed? Does the worker show up with raw materials already purchased and ready to perform work?
Typical W2:
Company sets start/stop times
Typically, position duration is not time-banded (not hired on project-basis)
Company provides office space, equipment/supplies, and/or training on how to perform job
Employee works ONLY for Company and does not “share” time with another Company
Company has control to direct employee on “what and how” work will be performed
Typical 1099:
Company hires worker for specific project or timeframe with no intention to continue relationship at the conclusion of project or timeframe
Company only controls outcome of work, worker has complete control over methods or how the work will be performed
Worker sets own stop/start times to comply with business needs
Worker provides own equipment and/or supplies to use on Company premises/project
Worker regularly works for other Companies, or it is expected that the worker would perform services for other companies as time permits
If one of the above scenarios perfectly describes one of the positions you’re trying to identify, you can stop here. More than likely, you have a “yeah, it’s like that but…”
Before we dive into situations where the worker seems to be a blend of W2 and 1099, let’s first review why we should bother looking at this anyway. In short, penalties.
Ignorance: “I had no idea…”
$50 for each missed W2
1.5% of employee’s wages + interest
40% of employee’s FICA
100% of employer’s matching FICA
20% of all employee wages paid
100% of FICA contributions (both employee AND employer)
Up to $1,000 criminal penalty for EACH misclassified employee
Up to 1 year in PRISON
Purposeful: “I knew it might have been off…”
Now we will dive into “grey” areas. Just because you’ve done research and honestly tried to classify your workers correctly, the final opinion lies with the Department of Labor (DOL) as they interpret the Fair Labor and Standards Act (FLSA) which governs how an employer compensates workers.
Let’s start this evaluation with reviewing the 1099 Contractor Affidavit Questionnaire. For this, we will navigate the IRS website…
Don’t worry, I went ahead and did it for you. The IRS identifies several employee categories, and here they are:
Independent Contractor
Employee
Statutory Employee (specific and specialized) https://www.irs.gov/businesses/small-businesses-self-employed/statutory-employees)
Statutory Non-Employee (most common in direct sales and real estate) https://www.irs.gov/businesses/small-businesses-self-employed/statutory-nonemployees)
Government Worker (public official/officer and elected officials)
Now that we know there are only 5 types of employees to choose from, we can start to narrow down our choices. More than likely, you won’t be looking at the Government Employee category because this is reserved only for government agencies. That leaves us with 4 to choose from.
We can really narrow the field down if your company is NOT involved in real estate, direct sales, vending, food delivery, laundry, dry cleaning, life insurance, at-home manufacturing, or B2B supply sales. If this describes your company, let’s move on (80% of companies can narrow the field). If your company is involved in one of the industries listed in this paragraph, you will likely need to hire outside help to correctly identify the worker(s) in question. Sorry...
Now that you have thrown out 3 classifications, we can focus on Employee or 1099… you know, the whole reason why you decided to read this stuff!
Remember how you outlined tasks, expenses, and reporting relationships earlier? Yeah, we’re going to use that finally. Let’s pretend we work for the DOL and are trying to make a determination if a worker is classified correctly.
First, look at people doing similar jobs. A big red flag would be to have 2 workers doing the same job but classified differently. This isn’t always a problem, but it would be a red flag worth investigating (you don’t want that). Even the IRS website says “Common industry practice is not an excuse to misclassify employees.”
Second, how does the worker behave when he/she is at the work location? What tools are needed for the work? What supplies are needed? If a worker must travel to multiple locations, what vehicle does he/she use and how is fuel handled? If physical work is being performed, who pays for the raw material, printer paper, computer, Personal Protective Equipment (PPE), lodging, etc.).
Third, does this worker keep different hours than others? This will likely be driven by the nature of the work. This is made most obvious in a formal office setting but can be translated to other situations. A team of employees working together on a project with supervision looks very different from a contractor hired for a specialized task at a specific time and working autonomously.
Feel confident yet? No? Yeah, even the DOL admits this is SUPER confusing. I did tell you we’d help you, right? That’s why we aren’t finished yet!
All the information and opinions online refer only to making this determination BEFORE you hire anyone for the position. Well, that isn’t us right now is it?! We need to take all the info out there and try to make it fit on top of what already exists! I can almost guarantee you will feel better after this exercise, but you will NOT be 100% sure it’s correct. The ONLY way to know 100% that you’ve done this part correctly would be to call the DOL and ask for an audit! Because they have the final say, anything we do from here on falls under “working in good faith”. Having completed a full review like this will add a decent amount of legal protection against fines and/or penalties.
PAY ATTENTION! If we finish this exercise, it is much easier to prove we were honestly trying to do the right thing. This will help to keep you out of the more brutal penalties the DOL can use for incorrect classification(s). Ignoring the issue and going about your business is not sufficient grounds to claim ignorance instead of malicious intent and could land you in the more severe penalty category.
Take the position in question with all we’ve put together now. What is the current classification for the position? Okay, whatever you just said, we are going to try and argue the opposite point in an attempt to “challenge” the current classification to see if it is correct. Keep in mind to focus on the work and who/what/when/where it is to be done. Look at the questions below for each category. These questions will test your current classification. Any “no” answers may warrant further research, but if 75% of the answers are “yes”, you are usually off to a decent start.
1099
Does the worker set his/her hours regularly?
Will the worker provide supplies, computer, tools, material to begin the work?
If travel is involved, do you provide a company vehicle or reimburse mileage?
Does the worker complete tasks using whatever methodology and material he/she chooses?
Are payments to the worker based on an invoice?
Was the worker already fully trained for the assigned work?
W2
Are stop/start times and work schedule set by company management?
Does he/she have all needed equipment provided by the company?
If travel is involved, do you compensate mileage or reimburse vehicle expenses?
Must the worker follow prescribed methods/materials for the same task?
When paying this worker, are taxes such as FICA withheld?
Did the worker require some training in a specialized task provided by the company?
You might not have matched on EVERY point above, but I’ll bet you got a little closer to making a determination. If you matched very well for around 75% of one type and not much on the other, your answer is right in front of you. What you’ve done now is analyze the position (not the person), evaluate all possible employment classifications, and done your very best to match the worker to the correct employment classification.
Now, if you could not match around 75% of the items above, you may need additional help from outside legal counsel or outsourced human resources services.
Either way, you’ve just now either classified your employees correctly, or at least recognized that you will need a little extra help to make the determination. You are now smarter and have a good understanding around the penalties for doing nothing, doing the wrong thing, and doing your best.
UPsourceHR.com is here to help with questions and quandaries like these. If you would rather solve this question with one of our staff or double-check your work, please reach out to us via email at info@upsourcehr.com to set an appointment.
