It is becoming all too common for businesses to hire outsourced help and treat them as regular employees. The prime motivation behind this strategy lies in these seemingly evident advantages - companies believe 1099 independent contractor they are reducing risk and it's much cheaper than hiring an in house employee (payroll tax, benefits, etc..).
Small business owners, heed this warning: The IRS is cracking down on companies that hire 1099 employees. They have stated that they will begin examining small business tax filings in order to search for potential abuse by businesses who take advantage of the benefits 1099 employees give to their employers.
The makers of QuickBooks, Intuit, recently posted on their blog, that only roughly six thousand of the twenty three million small businesses in the U.S. are currently under audit investigation for not properly classifying employees. The IRS actually states that as many as thirty percent of all employees are currently misclassified as contractors. Naturally, this hints to increased scrutiny by the IRS in the very near future.
If you've read this far you are probably scratching your head and pondering whether or not you have not properly classified some of your workers. In order to calm your worries I have compiled a list of what the IRS looks for when determining if a worker should indeed be classified as a 1099 contract employee. Take a look at the categories listed below and you will have a good idea of what the IRS is investigating.
Behavioral Relationship: Does the company have any control over how the employee does his/her job? More specifically:
- Is the worker required to be present in the company's office with a set work schedule? If so than he is probably a regular employee.
- Whose equipment does the contractor use? If the employee is on a 1099 he should be using his own equipment in whatever manner he sees fit.
- Are you directing the hiring of the workers that the contractor uses to do the job or is the contractor doing the hiring: In general, the contractor should have total freedom to do the hiring.
- How detailed are the instructions that you give the contractor? Remember, the contractor should have independence and freedom when completing the work.
- How is the contractor evaluated? If the evaluation is concerned with the details of the work process then the IRS will likely view the contractor as a regular employee and not a 1099 employee.
- Are you training these 1099 employees? That is a big no no in the eyes of the IRS. Training indicates that you are the one calling the shots. Remember, the contractor needs to be perceived as "independent." That's why 1099 employees are called Independent Contractors! They should already know how to do the job you are hiring them for.
2. Financial Relationship: Do you have financial control over the independent contractor's operation?
- The contractor should have a substantial investment in the tools they use to do the job
- You should not reimburse the contractor for their expenses in the course of completing the job. This should already have been included in the price they quoted the employer.
- Because of the fact that the independent contractor has a substantial investment in the tools required to perform the job and the employer is not refunding him/her for any expenses, the contractor is running the risk of losing money. This characteristic is more indicative of an independent contractor.
- The independent contractor should be able to sell his services to anyone. He should be free to engage in business with other companies as he/she sees fit.
- The independent contractor should receive a set fee for their services, not a salary.
3. The kind of Relationship:
- A contract should be written out detailing the fact that the employee is a contractor. Remember though, just because the contract says that the worker is a contractor doesn't mean the IRS going to take your word for it. The IRS will closely examine the nature of the relationship that exists between the employer and the contractor.
- The contractor should not receive any benefits from the employer if they are an independent contractor.
- The relationship between the employer and the contractor should not be with the understanding that there is no finite period of employment. The contractor should be employed only for a particular project. You can rehire the contractor in the future, but there should be no long term contract..
- The services that the contractor provides should not be for a crucial activity of the business. This is a red flag for the IRS because it indicates that the employer probably has much more proactive control over the contractor's work.
I strongly urge any small business owner who has 1099 employees to visit the IRS's Voluntary Worker Classification Settlement Program. The information provided there can save you the embarrassment of an IRS audit of your business. In exchange, for your voluntary cooperation with the IRS to properly classify your workers, your company will be eligible to receive partial relief from federal employment taxes and a promise from the IRS to not audit the business for how employees were classified in prior years. I also suggest that you consult a bookkeeper or an accountant for any questions you may have.