What is a 1099 Employee? The Essential Guide for Employers

Strictly speaking, there is no such thing as a 1099 employee. This is a bit of a misnomer, but is often used for describing an independent contractor. This shows how easily terms can be the reason why workers are misclassified, landing your business in trouble with local authorities.

In this ‘Essential Guide for Employers’, we discuss how things can get mixed up, why misclassification of workers is bad for business, and how you can avoid making common mistakes related to hiring independent contractors.

Key Takeaways

• A 1099 employee is an independent contractor, and is not classified as an W 2 employee by federal and state laws.
• Employee misclassification has significant financial implications and can lead to reputational damage.

What is a 1099 employee?

A 1099 employee is a term used for an independent contractor. This term originated from 1099-NEC (Non-Employee Compensation), which is submitted to the Internal Revenue Service by businesses that hire contractors.

However, as stated previously, someone cannot legally be called a 1099 employee. There are very important reasons for this that go beyond semantics. A 1099 worker is a self-employed person, and therefore, you do not withhold federal income tax, Social Security, and Medicare taxes from their pay.

They are responsible for their own tax obligations in the form of self-employment tax, and do not receive any benefits from your company. This excludes a contractor from being classified as a W2 employee.

Before going further, there is another working relationship that is often misunderstood. This is fully explained in ‘Subcontractor vs independent contractor, and may help you further refine contractor relationships.

Employee or independent contractor? What’s the difference?

Now that we’ve made the important distinction between a W-2 employee and an independent contractor, it is clearer that the difference lies not in the terms but in where the control and independence lie. Let’s explain.

The IRS uses a Common Law Test based on three categories to define control for employment tax purposes:

Behavioral control

This speaks to who controls the work that is performed and how it is delivered. For employees, the business:

• Sets the working hours.
• Is responsible for training and managing performance.
• Pay employment taxes on behalf of the employee.
• Supervises daily work according to company rules, and the worker’s job is controlled by a manager or supervisor.
• Treats the person as a company worker.

For independent contractors, the objectives are different:

• The contractor decides how the work is done (procedural).
• They use their own tools and resources to complete the job, task, or project.
• They receive no training from the client company.
• They are evaluated on the outcomes agreed in the contract.

Financial control

This category determines who controls the financial aspect of the working relationship. It tests whether the employer has direct influence and control over business aspects of the worker’s job.

An employee has no direct control over the finances of the company and how they are used. They are:

• Paid hourly, weekly, or monthly by the employer.
• Reimbursed expenses when fulfilling tasks or travelling for the company.
• Given the tools, resources, and equipment they need to fulfill their jobs.
• Free of risks associated with company profit or loss.

An independent contractor, on the other hand:

• Is paid after submitting an invoice to the client company.
• Is responsible for paying their own business expenses and deducting them when they pay taxes.
• Buys their own tools and equipment to fulfill the objectives agreed with them.
• Must manage the financial profit or loss associated with running their business.

Type of relationship

The last category in the IRS Common Law Test is about how permanent and integrated the working relationship is.

Employee	Independent Contractor
Ongoing according to an employment contract.	Temporary contract-based employment that ends after the job or project concludes.
Receives benefits from the company as part of the employment relationship.	Receives no benefits from the client company.
Is integral to the core operations of the company.	Operates a separate business and is therefore not integral to the core operations of the client company.
Is seen as part of the company and team they are part of.	Is not a recognized member of any team or department in the client company.

This IRS classification system helps employers to clearly distinguish between W2 employees and self-employed workers (contractors). Business owners who stick closely to these guidelines can avoid the unpleasant consequences of employee misclassification, such as fines, penalties, and unpaid wages and benefits.

What are the implications of the misclassification of workers?

Protecting your business from misclassification problems is not just about compliance, but it's a smart financial strategy. The financial losses that will occur if either the IRS or the state changes the worker classification will cut into your bottom line, and if you’re a small business, it could result in something worse. The full picture of what you may be liable for looks like this:

• Unpaid tax liability (such as income tax withholding and payroll taxes).
• Employer portion of Social Security and Medicare.
• State unemployment taxes.
• Workers’ compensation insurance.
• Back wages (including overtime pay and vacation pay).
• Payment for minimum wage violations.
• Employee type benefits (e.g., pension plan, retirement plans, health insurance).

How are workers misclassified?

You may be wondering how it’s possible to classify W 2 employees as contractors and vice versa. Sometimes it's a way to save money. Hiring a traditional employee costs much more than an independent contractor.

You don’t need to provide employee benefits, and you are not responsible for the tax liability or for paying unemployment tax. Other times, it's about managing workforce numbers, or lines getting blurred between employees, independent contractors, and subcontractors.

Whatever the reason, the Fair Labor Standards Act and the IRS provide clear guidelines, and therefore, it's risky business to get employee classification wrong. This becomes even more complex when you want to hire and pay contractors in other countries.

Each country has its own set of rules governing employee classification, and the consequences for non-adherence are equally disruptive. If you’d like to delve further into global contractors, ‘How to Manage Global Contractors Compliantly’ is the complete guide for hiring, onboarding and paying global contractors.

How you can avoid misclassification with a Contractor of Record (COR)

One way businesses are navigating through these challenges is to partner with a Contractor of Record (COR) company, such as Rivermate. The COR hires the contractor, classifying them correctly according to local laws and regulations. They also craft airtight contracts, protecting you from loopholes, and can onboard contractors in hours.

With Rivermate, you can manage your contractor relationship on the Rivermate platform. It provides access to contractor invoices for your approval, and Rivermate pays the contractor once you’ve approved the invoice. Nothing could be easier. Talk to a Rivermate expert about your contractor needs.

When should you reclassify your worker

By answering these simple questions, you will be able to correctly classify your workers. The starting point is always: ‘Are aspects of the worker’s job controlled directly by the company?’

Question	Employee Indicator	Contractor Indicator
Who controls how and when work is done?	Company	Contractor
Who sets working hours and other labor rules?	Company	Contractor
Who provides tools, equipment and resources?	Company	Contractor
Who pays the federal and state income taxes?	Company	Contractor
Payment method?	Hourly, daily, weekly, and monthly wages	Invoice
Has multiple clients not related to the company?	No	Yes
Employment relationship	Full-time employees, part-time workers	Contractor, sub-contractor

This checklist provides a quick way for you to evaluate independent contractors, but you should always refer to the most important aspect, which is the control of work. If you realize you have a misclassification risk on your hands, it is best to correct it proactively.

Discuss with the contractor, and either change the worker’s status or clarify working boundaries to prevent a W 2 employee classification.

Expert insight: Avoiding Contractor Misclassification: A Guide for Businesses delves further into steps you can take to avoid misclassification of workers.

Conclusion

A 1099 employee is the common term used to describe an independent contractor. However, technically, a contractor cannot be called an employee since they do not work for a company; they own and run their own business.

Terms like ‘1099 employee’ can create the wrong idea about the working relationship, both for the employer and legally. For this reason, the IRS and the Fair Labor Standards Act clearly define who can be classified as an employee and who is an independent contractor.

Misclassifying workers can lead to financial challenges and reputational damage for companies. For this reason, attempts should be made to keep the boundaries of the working relationship with contractors clear. The starting point for this should be a high-level of independence for the contractor in how and when work is done.

A Contractor of Record provides companies with an alternative to working with contractors. By using these services, you can avoid worker misclassification and are provided with a safer, more efficient way to manage your contractor relationship. This helps you to avoid the negative financial consequences of misclassification, should your worker’s status be challenged by the local authorities.

Rivermate not only manages contractors but also extends the capabilities of your current HR team by providing Employer of Record and recruitment services. Book a demo with a Rivermate expert and confidently manage remote employees and contractors (both locally and globally).

FAQs: What is a 1099 employee?

1. What does it mean if an employee is 1099?

When an employee is 1099, it means the person is an independent contractor. They are classified as a self-employed worker by the IRS, and according to the Fair Labor Standards Act. They run their own business and control the work that is done, and how it is done. They are also responsible for their own tax obligations and do not receive any benefits from the companies they work for. They are not paid a salary, but rather issue an invoice for payment. Contractors are only hired to work on tasks or projects for a set period of time.

2. What are the downsides of being a 1099 employee?

A 1099 employee is not actually an employee of one company. A 1099 worker is self-employed and therefore does not have the same worker protections as a salaried employee. They also do not receive a consistent monthly salary or employee benefits. They must also provide for their transportation, resources, and equipment to do the job they have been contracted to do. They may also get paid less than their salaried counterparts for doing the same work. These are some of the most common downsides to 1099 employment.

3. Does a 1099 employee pay taxes?

Yes, a 1099 employee does pay taxes. As a self-employed worker, they are responsible for paying income tax and self-employment taxes. Currently, it is 15.3%, consisting of 12.4% for social security and 2.9% for Medicare. These taxes are calculated using Schedule SE and Form 1040. To pay self-employment tax, you must have a Social Security number and a tax identification number.