How do you know if an employee is a 1099 or W-2 employee? People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether these people are independent contractors or employees depends on the facts in each case.
The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.
A W-2 employee performs services that can be controlled by the employer (what will be done and how it will be done), even if given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed. The earnings of a W-2 employee are subject to FICA (Social Security Tax and Medicare) and income tax withholdings, but not subject to Self-Employment Taxes.
Still not sure if you or an employee are classified as a 1099 or W-2 employee? Here is a check list to help with the classification of a 1099 employee. To be a 1099 employee, ALL of the following criteria must be met:
- They engage in work for more than one client: If you’re paying a single independent contractor for 35 hours or more hours per week, it’s unlikely they are performing any significant work for anyone else. Give them a full-time position with benefits or cut back the hours to avoid scrutiny.
- They don’t work in your office: Independent contractors may have meetings on-site or be occasionally expected to perform certain tasks at your business, but they shouldn’t be working there all day for months at a time.
- They have their own equipment: An independent contractor is a business owner; therefore, they should come equipped with all the tools of the trade. Giving a contractor a work laptop or phone may raise eyebrows at the IRS.
- They have flexibility in when and how their work is performed: Employees are expected to be available for a set of regular hours and may be subject to frequent check-ins. That’s not the case for independent contractors, who generally are free to complete work on flexible schedules and should be only accountable for meeting pre-arranged deadlines.
- Their roles aren’t essential functions of your company: For instance, if you’re hiring an independent contractor to design your website, you’re A-OK; this is a temporary role that’s not central to your business’ line of work. On the other hand, if you’ve hired a 1099 worker to head up your marketing team on a permanent basis, you could be subject to penalties.
Now for the exceptions to the general rule: If workers are independent contractors under the common law rules, such workers may nevertheless be treated as W-2 employees by statute (statutory employees) for certain employment tax purposes. If they fall within any one of the following four categories AND meet the three conditions described under Social Security and Medicare Taxes (See Social Security and Medicare Taxes Below):
- A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is paid on commission.
- A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company.
- An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done.
- A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. The work performed for you must be the salesperson’s principal business activity.
Social Security and Medicare Taxes
Withhold Social Security and Medicare taxes from the wages of statutory employees if ALL three of the following conditions apply:
- The service contract states or implies that substantially all the services are to be performed personally by them.
- They do not have a substantial investment in the equipment and property used to perform the services (other than an investment in transportation facilities).
- The services are performed on a continuing basis for the same payer.