In a study conducted by Intuit, 40 percent of the American workforce will be freelancers, contractors, and temp workers by 2020. Even now, many companies are replacing some of their full-time employees with part-time professionals, freelancers, and independent contractors. Some are keeping a present employee, but changing the status from employee to independent contractor. The changing workforce requires employers to be ever more vigilant about the questions and compliance requirements surrounding independent contractors.
Is that former employee – now contractor – or the new contractor truly a 1099 independent contractor or does he/she require a W-2? The difference is significant. You withhold and manage taxes for employees; while independent contractors pay their own based on the 1099s they receive (Form 1099 is the independent contractor’s equivalent of a W-2). The IRS expects you to know the difference between a W-2 employee and a 1099 independent contractor. In addition, you must make the correct annual filings with the IRS for both W2 employees and 1099 contractors. If you get it wrong, the penalties are high.
So how do you know the difference?
Ask the right questions.
1. Do you set the hours or does the worker set his or her own hours?
2. Naturally, you know what work you want accomplished, but who sets the guidelines for how, when, and where the work will be accomplished – you or the worker?
3. Does the worker furnish his or her own tools and equipment and hire his own assistants if needed?
4. Does the person have a workplace, home office, equipment storage, etc. that belongs specifically to him and is at a separate location from your business?
5. Does the individual work only for you – or is he/she free to obtain work for other companies simultaneously?
6. Do you set an hourly wage/salary or does the worker set his/her own rates/commissions per job?
7. Do you receive an invoice from the worker for his services?
8. Did you sign a contract for the work he/she is accomplishing on your behalf?
Using independent contractors to perform a multitude of tasks is beneficial for most businesses, involving far less liability and obligations than W-2 employees, and potentially eliminating the provision of employee benefits, insurance, tax withholding, etc. It is crucial; however, to not only classify an individual correctly, but to understand 1099 compliance.
Before hiring an independent contractor and signing a contract:
• Assess the independent contractor’s business and require pertinent documentation.
• Ask the independent contractor to complete a questionnaire specific to 1099 workers. Include a checklist that helps to determine if the worker is accurately classified as an independent contractor versus an employee.
• Sign a written contract with and maintain a separate file for each independent contractor. This file may include, but isn’t limited to the following documentation:
1. Copies of tax returns showing the contractor filed a Schedule C for the past couple years if he or she is a sole proprietorship
2. Copies of 1099 forms by other companies for whom the consultant has provided services
3. Professional licenses and proof of insurances
4. The signed independent contractor employment agreement and any other drafts of it
5. W-9 form signed by the consultant
6. List of equipment and materials the 1099 professional will use to perform services and costs
7. All invoices submitted for billing purposes
Written contracts are imperative and protect both your business and the independent contractor. Make sure your agreements include an Independent Contractor clause that clearly identifies the roles of the parties. Also, make sure you are managing your 1099 contractors and tracking 1099 payments correctly in order to comply with annual filing requirements.
Hiring independent contractors can be a tremendous benefit to your business.Contact Virtual Paralegal Services. We will help you create your questionnaires, draft your contracts, and help manage and maintain 1099 compliance.