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Knowing the Difference of W2 & 1099

Here is a simplified explanation of the differences between employees and independent contractors based on the article:

The US Department of Labor and IRS have different tests to determine if someone is an employee or independent contractor. This can be confusing for employers with workers in multiple states.

An employee has a permanent job with set hours and responsibilities overseen by their employer. They are owed minimum wage, overtime pay, breaks, unemployment insurance, workplace protections, and more.

An independent contractor is hired temporarily to complete a specific task or project. They have more freedom and flexibility over how and when the work gets done. They provide their own tools/equipment and pay self-employment taxes.

Some key factors that suggest someone is an employee include:

The employer sets their schedule and supervises their work
The work is core to the employer’s business
They have been working there long-term
They rely on the employer for most or all of their income
Factors that point to independent contractor status include:

Key Factors Indicating Independent Contractor Status:

Business Decisions: The individual has the autonomy to make decisions that can affect their profits or losses.

Specialized Skills: The individual possesses specific skills or expertise required for the projects or tasks they undertake.

Multiple Clients: The individual provides services to multiple clients or customers, rather than relying solely on one employer.

The best practice is only classifying true independent/contract work as 1099, not ongoing jobs that look more like traditional employment. Employers should carefully evaluate each worker based on both the DOL and IRS tests to ensure proper classification.

Examples of independent contractor tasks:

Website design/development
Accounting/bookkeeping services
Legal consulting
Graphic design work
IT troubleshooting/ repairs
Photography/videography jobs
Freelance writing/editing
Tutoring/private lessons
Consultations/training sessions

Consequences of misclassification:

Backpay of taxes/benefits for misclassified employees
Penalties/fines by DOL or IRS of $1,100-$5,500 per violation
Lawsuits from workers seeking wages/benefits owed
Joint liability for employment law violations

 

Ways for employers to properly classify:

Review each job function based on guidelines
Issue 1099-NEC forms to independent contractors
Have contractors sign a valid written agreement
Don’t set mandatory schedules/methods
Allow contractors to provide services to multiple clients
Document analysis and conclusions
Seek legal counsel if unsure of proper status
Re-evaluate classifications annually

Proper classification is important for employer compliance and to avoid penalties. Taking care to analyze each role individually can help ensure workers are enjoying all applicable protections and benefits.

Industries most affected:

Real estate brokers – often incorrectly classified as contractors
Insurance brokers – same issue as above
Rideshare/delivery drivers – gig jobs now facing reclassification
Construction subcontractors – may need to be reevaluated
Massage therapists – often 1099 but could qualify as employees
Community managers – ongoing work looks more like employment

Specific guidelines for IC classification:

The contractor must be free from control/direction over performance
The work done must be outside the usual business operations
The contractor’s business/skills must be established before the work begins
The relationship should not be permanent/exclusive
The contractor must have an opportunity for profit/loss
1099-NEC is for non-employee compensation like contracting work. It is submitted to report payments to individuals not classified as employees.

W-2 is used to report wages, withholdings, and taxes for workers classified as employees. It includes data like Social Security and Medicare taxes.

Resources for employers:

IRS publication 1779 on worker classification
DOL website resources and fact sheets
Use free online tools like ELA’s worker classification wizard
Consult with an employment law attorney for specific scenarios
Reach out to state labor department for state-specific guidance
Proactively reviewing classifications regularly can help ensure compliance and avoid issues down the road as laws continue to evolve.

IRS Classification Test:

The IRS primarily looks at whether the business has the right to direct/control how the work is done, or only controls the final result. Key factors include:

Behavioral control- if they control how/when work is done
Financial control- how expenses/liabilities are handled
Relationship type- full-time, on ongoing basis, etc.
Penalties for Misclassification:

If misclassified as a contractor, employers owe back payroll taxes
Penalty per employee of $250-2,500
Employees may file lawsuits for owed overtime, benefits, etc.
How the New Rule Affects Workers:

Workers now properly classified as employees will qualify for minimum wage, overtime, FMLA, discrimination protections, etc.
Unemployment benefits and workers compensation coverage
Potential to bargain collectively through unions

Tips for Gig/Independent Workers:

Incorporate as an LLC or S corporation if possible
Issue proper invoices/contracts for services
Set your own hours and work methods
Provide services to multiple companies if applicable
Make financial investments in your business/tools
Market yourself as an independent brand
Overall, properly determining status upfront helps ensure compliance and that all parties understand their rights/responsibilities. Consulting experts can help navigate specifics.

How to Incorporate:

LLCs provide liability protection and pass-through taxation by filing articles of organization with your state. Costs ~$50-500.
S Corps elect pass-through taxation by filing IRS Form 2553. Requires issuing stock and keeping minutes/records.

Business Investments for Gig Workers:

Tools/equipment – laptop, phone, vehicle for transportation services
Software/licenses – QuickBooks, invoicing platforms, app fees
Marketing – website, business cards, social media ads
Insurance – liability, equipment coverage, E&O policies
Certifications and education: Investing in classes, certifications, or education to further develop skills and obtain relevant credentials.

Marketing as an Independent Brand:

Create a professional website/online presence
Craft an “about me” with credentials and specialties
Utilize social media to showcase experience and work
Leverage online directories/review sites
Partner with related influencers for referrals

Recommendations:

Review classifications now using IRS/DOL tests
Incorporate independent contractors as LLCs/S Corps if long term
Draft contracts specifying independence of workers
Importance: Rules take effect 3/11/2023 with potential enforcement starting soon after. Proactively ensuring correct classifications can avoid compliance issues and penalties down the road. The self-employed represent a growing demographic and following regulations protects workers and businesses.

Here are some additional details on the new classification standards:

Classification Standards for Gig Workers:

Economic Dependence and Control: The new tests place greater emphasis on the worker’s economic dependence on the employer and the level of control the employer exerts over the work.

Reclassification Risk: Gig and on-demand jobs face a higher risk of reclassification as employees.

Demonstrating Independence: Workers who can demonstrate independence by setting their own hours, using their own equipment, performing services outside the main business, and taking on opportunities for profit or loss are more likely to retain their contractor status.

Guidelines for Employers:

Don’t set worker’s hours, schedules or dictate how tasks are performed
Allow workers to perform services for multiple businesses
Issue 1099-NEC forms for independent contractors
Use written contracts specifying independent contractor status
Consider additional tax/benefit stipends to offset contractor costs
Re-evaluate all classifications annually for changes

Resources on Industry Impacts:

Kellogg School discusses impacts on gig platforms: https://www.kellogg.northwestern.edu/faculty/directory/articles/gig-platform-workers-and-the-new-independent-contractor-rule.aspx

Cornell outlines construction, tech and healthcare impacts: https://www.ilr.cornell.edu/news/impacts-dol-independent-contractor-rule-selected-sectors

SHRM analyzes effects in delivery, home services and rideshare: https://www.shrm.org/resourcesandtools/hr-topics/compensation/pages/dol-delivers-independent-contractor-standard.aspx

 

The key is ensuring each worker’s classification aligns with how your business actually operates to avoid enforcement risks and compliance issues.  Get Help For Your Business Here