Missclassification: Independent Contractor vs Employee
An area that continues to be under scrutiny by both the IRS and the Department of Labor that directly affects the staffing and employment industries is the misclassification of 1099/independent contractors
To a client, as well as contractors, it may seem alluring to treat a worker as an independent contractor as opposed to an employee. The benefits of an independent contractor include lower tax burden, avoiding the rigidity of strict employment laws, and the ability to engage in temporary contracts with no further obligation.
However, treating a worker as an independent contractor, when the nature of the work being performed contains elements of an “employee-employer” relationship opens up a client as well as workers to misclassification risk.Your candidates will first need to understand the risks of having a 1099/independent contractor relationship as opposed to the benefits and securities of becoming a W2.
Below we’ve provided a step-by-step guide for how to encourage and assist your candidates in the transition from 1099 independent contractor to W2-employed contractor:
Step One: Raise Awareness Regarding Misclassification
The risks of employee misclassification carry major potential penalties for several parties, and if communicated effectively to the contractor, can go a long way to changing his/her mind about choosing to participate in the benefits of a W2.
First off, it’s important to understand that in order to avoid misclassification, any characteristics of an employer-employee relationship between the client and the independent contractor, must be eliminated. Here are some key, common elements of an employer-employee relationship that the IRS specifically outlines as targetable activities for misclassification:
Workers are provided with detailed/frequent instruction from the client; the worker is unable to make independent decisions as to how and when the work will be done and in what sequence
Equipment, supplies, and tools are provided for at the worksite by the client
The worker is provided with performance evaluations by the client based on how the work is performed rather than the end result
The client provides the training needed in order to complete the project
There is no risk on the worker for any kind of financial loss/gain as a result of providing services (aside from regular pay or salary)
The worker is employed for business and travel expenses
The worker is being paid an hourly wage or salary based on the amount of time spent providing services rather than the end result
The worker is held to a non-compete or restricted from providing services to other clients/companies while providing services to the client
Service is provided by worker is a key aspect of a client’s business (i.e. a computer programmer working for an IT firm)
The worker is provided coverage under the client’s worker’s compensation policy/General Liability policy
The worker is provided with client benefits including paid vacation/sick pay, medical coverage, 401k, etc.
The worker is intended to be long term, ongoing or potential for renewal
*It is important to note that the IRS does not give any weight to contractual documents stating that the worker is treated as an independent contractor. The IRS uses the balance test, taking into consideration the points listed above regardless of any agreement between client and worker that states otherwise.
Step Two: Communicate Additional Risks & Potential Consequences
There are substantial liability and tax exposures to consider in the event that an independent contractor is misclassified. While most clients want to maintain compliance as much as possible, more often than not a client or worker is unaware that the work being performed should legally be treated as an employee. The client’s inexperience or lack of knowledge of the laws and procedures is no defense to a misclassification claim or audit.
Improper classification can result in tax penalties for failure to withhold employment taxes such as FICA, FUTA, and Workers ’ Compensation as well as penalties for back wages due to non-compliance with minimum wage and overtime. In addition to penalties and back pay responsibilities, the client could be found liable in case of an on-site accident, contractor negligence if the worker did not carry their own worker’s compensation or general liability insurances.
Step Three: Stress the Advantages of Being a W2-employed contractor
Now that your candidate(s) have a much better understanding of the threat of misclassification and other risks detailed above, let’s communicate to them the multitude of benefits associated with operating as a W2-employed contractor over an independent contractor. Here are a few specific key benefits and upgrades that become accessible to a contractor who switches from 1099 to W2:
The contractor is paid on a set pay schedule with the option of direct deposit
The contractor has access to employee benefits, such as medical insurance, vision, dental, and life insurance
The contractor is eligible for unemployment insurance
The contractor is covered under the employer’s Worker’s Compensation Plan and key liability insurances (General, Professional, Errors/Omissions, Auto, Crime Bond, Theft)
The contractor is free from having to deal with frustrating collection issues with the client
The contractor does not have to generate invoices for the Client
The contractor does not have to negotiate or create any contracts; the Employer’s legal resources can handle all contractual matters
The contractor does not have to do their own quarterly tax filings
The contractor is eligible for overtime pay, per state regulations
Step Four: Provide a Factual Resource
In order to stress that this is a very real threat, you can provide your candidates with this link to the IRS government website, which explains misclassification in great detail.
In Conclusion…
As you can see, when providing key information on the disadvantage of being an independent contractor/1099 versus the benefits of being a W2-employed contractor, the choice should be clear. By presenting clear factual information that stresses both the dangers of independent contracting as well as the benefits of W2 employment.
It’s also important to note, that ultimately, whether the contractor goes 1099 or W2 is actually not that contractor’s choice. It’s the client’s first, as they are the party who stands to incur the highest degree of risk in a non-compliant relationship structure.
Disclaimer: All information written here is for general informational purposes only and is not intended to be a substitute for professional and/or legal services.