Hiring a 1099 Worker? Be Aware of the Updated Guidelines for Determining Employee/Contractor Status
You're starting a new small business. As with any new business, you face uncertainty and want to keep costs down. You hire someone to design your website and help with Search Engine Optimization. You don't pay overtime. No social security and medicare taxes. No unemployment or worker's compensation insurance. You start to file the 1099-MISC form for non-employee compensation. And then...
You find out that you should have classified the worker as an employee, rather than as a contractor. In that case you owe taxes, extra wages, and more. Ouch!
How can you tell if a person you hire is a contractor or an employee? While there are some guidelines, the rules are not hard-and-fast. Many factors contribute to the determination. The IRS can make a determination for you if you complete Form SS-8. It's free – but you have 6 months for the results.
Your alternative is to make the best decision you can with the facts you have. Here are some guidelines that may help you determine if the worker is an employee or a contractor.
“Economic Realities Factors”
In July, the Department of Labor (DOL) released guidelines reviewing the determination standards. The "Administrator's Interpretation" outlines 6 factors that are key to the determination. The review considers the Fair Labor Standards Act’s “Suffer or Permit” standard. The interpretation includes case law references and specific examples. We've summarized the 6 factors below.
1. “Is the work an integral part of the employer’s business?”
Carpenters working for a furniture company are likely employees and not contractors. A carpenter who builds a bookcase for your bookstore is likely a contractor.
2. “Does the worker decide how to complete tasks? Does the worker take responsibility for profit and loss?”
If the worker makes decisions that impact their profit, the worker is likely a contractor. Contractors hire others, buy materials and advertise. The employer does not have managerial rights in these areas.
3. “How does the worker’s investment compare to the employer’s investment?”
Employees do not make large investments in tools to perform the job. Contractors might make large investment in tools for their personal/professional use. Note that there isn’t a specific dollar amount for these types of investments.
4. “Does the work performed require special skill and initiative?”
Don’t confuse the skills here with technical skills. An accomplished carpenter may still be an employee rather than a contractor. The worker must operate as an independent business to qualify as a contractor.
5. “Is the relationship between the worker and the employer permanent, or indefinite?”
An employee typically has a permanent or indefinite arrangement with one employer. A contractor may work for several employers. An employer may have hired the contractor to complete a specific task.
6. “What is the nature and degree of the employer’s control?”
This point can be a bit of a grey area. Some employees exercise flexibility in their scheduling and day-to-day tasks. A worker who makes choices doesn't have to be a contractor.
Each factor contributes to the larger picture of the work the person does. No one factor determines the worker's status. You should also review the factors in light of the FLSA’s definition of employment.
“To Suffer or Permit to Work”
First of all, no one uses phrases like “the employer suffered the employee to work” anymore. An employer suffers or permits an employee to work by knowing an employee is working. If no worker clocks in at your deli, but the sandwich prep gets done, you don’t have prep-elves. You are suffering or permitting an employee to work off the clock, and the DOL may ask you about it one day.
The FLSA includes “to suffer or permit to work” as part of the definition of employment. This definition establishes the relationship between the employer and the worker. The Act uses this definition to determine which workers are protected under the Act. A worker who falls outside of the “suffer or permit to work” scale is a contractor. The FLSA does not protect contractors in the same way they protect employees. Contractors do not receive overtime pay, for example.
View each of the 6 economic realties factors in the context of this definition.
Proceed with Caution
Business owners have to decide how to label workers. Be aware of the guidelines and work as best you can within them. If you are unsure of the classification of a worker, reach out to the IRS with form SS-8.