A 1099 employee is a term used for US self-employed worker that reports their income to the IRS on a 1099 tax form.
This is part of an extensive series of guides about compliance management.
What is a 1099 Employee?
Freelancers, gig workers, consultants and independent contractors are all considered 1099 employees although they are not employees at all. Their accurate term is actually self-employed workers or non-payroll workers.
Unlike employees, self-employed workers are responsible for reporting their own income and paying their own self-employment taxes, which cover Social Security and Medicare. They are not defined as employees legally, therefore the term 1099 employees is quite problematic.
Below is a breakdown of 1099 ’employees’ and what you need to know if you’re considering hiring them.
What Qualifies as a 1099 Employee?
Simply put, a 1099 employee is a non-payroll worker. They might be self-employed or they may own a business, but they are not an employee of your business. Usually, if you offer a worker a long-term contract, an open-ended role with your company, and they have a job description that they need to keep to, they are not a 1099 employee.
On the other hand, if they have a short-term role or project to do with your business, and they have control over how they complete that work, they are likely to be a 1099 employee.
How to Classify a 1099 Employee
A worker is considered self-employed if the paying company cannot control or direct how the work is done. To help employers make this determination, the IRS offers three “common law rules” to consider:
- Behavioral: Does the paying company control or have the right to control what the worker does, as well as how the worker does their job?
- Financial: Does the paying company control the business aspects of the worker’s job, such as how the worker is paid, whether their expenses are reimbursed, or who provides equipment/supplies?
- Type of relationship: Is there a written contract? Does the worker receive employee-like benefits from the company, such as a pension plan, insurance, or paid time off? Is the relationship on-going, and is the work performed a key aspect of the business?
Businesses must review all of these questions when classifying a worker as a 1099 employee or a W-2 employee. Often, the answer isn’t black or white — some factors may indicate a worker is self-employed while others may suggest the relationship is employee-employer.
According to the IRS, “The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.”
1099 Employee Rights
What rights does a 1099 employee have? As they are not actually an employee at all, self-employed or 1099 workers do not have the rights that we tend to think of when we consider employees, such as sick pay, overtime, parental leave, or pension plans.
Instead, 1099 employees have the right to act unlike a regular on payroll employee. They have the right to work in the location of their choice, the right to set their terms for payment, and the right to work during the hours that are agreeable to them.
If you don’t set out specific terms in your freelancer contract, you might find that the way that your 1099 employees work isn’t a good fit for you. For example, they could terminate the agreement without notice, consider themselves to own the output of their work, or be unavailable for meetings or team get togethers.
1099 Employee Benefits
While traditional employee benefits aren’t a factor for 1099 employees, there are many benefits to being your own boss. Independent contractors have the freedom to say yes or no to specific projects or clients, take time off as and when they choose, and set their own prices – raising them at their own prerogative.
It can be helpful to offer your 1099 workers certain benefits to make sure that you’re their preferred client! This could be learning and development opportunities – such as inviting them to courses or to hear visiting speakers, or it could be holiday bonuses, or inclusion in corporate away days.
While employee benefits like vacation days and retirement funds need to be factored into their ongoing costs, for many – the autonomy and freedom of being a 1099 employee is all the benefit that they need.
The 3 Advantages of Hiring 1099 Employees
Here are the three main advantages of working with 1099 employees over W-2 employees.
#1 Lower business expenses
Unlike regular W-2 employees, paying companies are not required to pay taxes on behalf of self-employed workers, contribute to workers’ comp or unemployment insurance on their behalf, or provide health benefits. Companies are not subject to a minimum wage limit or overtime regulation, nor do they need to provide sick days or retirement benefits.
At the end of the day, businesses can save as much as 30% on human capital and associated costs by enlisting freelancers or other types of self-employed workers, according to Business Law Today.
#2 Access to elite talent
Best-in-class workers increasingly opt to work for themselves in order to enjoy the benefits of a flexible work schedule, freedom to set their own rates, and the ability to pick and choose which customers to take on.
Businesses that work with 1099 employees will gain access to this highly desirable pool of talent, which enables them to produce better outcomes.
#3 Greater market agility
With a smaller permanent workforce, businesses are leaner and more agile in the face of unexpected changes or sudden loss of budget. It’s much easier to end a working relationship with a self-employed worker than a full-time employee. On the more positive side of this point, it’s also much faster to dive into work with new freelancers for project-based work than it is to interview, hire, and onboard new employees.
What are a 1099 Employee’s Rules?
Your 1099 employees need to take responsibility for filing and paying their own self-employment and income taxes. The self-employment taxes pay for social security and Medicaid, while income taxes are based on how much they have earned in a given tax year. Your business is not responsible for withholding taxes from a 1099 employee’s earnings.
For the business, the rules are pretty simple. You report the earnings of your independent contractor using form 1099-MISC if you have paid them $600 or more during that tax year. If you misclassify an employee as a 1099 worker in order to reduce your tax burden, you could face hefty fines and serious business penalties.
Can you Collect Unemployment if you are a 1099 Employee?
The system for unemployment payments in the U.S. is funded by Federal Unemployment Tax Act (FUTA) taxes and State Unemployment Tax Act (SUTA) taxes. As a business does not pay state and federal unemployment taxes for a non-payroll employee, an independent contractor cannot collect unemployment. This means freelancers do not qualify for unemployment.
However, in certain situations there may be funds available for 1099 employees who are out of work. For example, during the COVID-19 pandemic, the government made funds available for small businesses, including many 1099 workers, who were out of pocket due to the virus.
What are the different categories of 1099 employees?
As self-employment rises in popularity, a variety of definitions have emerged to distinguish the different natures of work. All of the following titles can be considered 1099 employees.
- Freelancer — An individual who earns money by the job, task, or hour, usually for short-term work. Freelancers often work with multiple clients simultaneously, unless contracted to work exclusively for one company.
- Gig worker — Someone who performs temporary, flexible jobs, often through an online app or platform. Uber, Lyft, Instacart, and other driver-based companies operate on gig worker labor.
- Crowd workers — Also known as crowdsourcing or platform work, crowd work refers to the outsourcing of tasks to a large pool of online workers via an online platform, rather than to a single worker or employee.
- Outsource teams — Third-party or external teams that are not part of your organization may be enlisted to perform tasks, handle operations, or provide services to a paying company.
Who needs to file a 1099 tax form?
Any self-employed individual who earns a total of $400 or more from all of their clients in one year is required to report their income to the IRS and pay taxes on it. The IRS considers a worker to be self-employed if they meet any of the following criteria:
- They perform a trade or business as a sole proprietor or an independent contractor
- They are a member of a partnership that carries on a trade or business
- They are otherwise in business for themselves, including part-time work
The 3 advantages of hiring 1099 employees
Here are the three main advantages of working with 1099 employees over W-2 employees.
#1 Lower business expenses
Unlike regular W-2 employees, paying companies are not required to pay taxes on behalf of self-employed workers, contribute to workers’ comp or unemployment insurance on their behalf, or provide health benefits. Companies are not subject to a minimum wage limit or overtime regulation, nor do they need to provide sick days or retirement benefits.
At the end of the day, businesses can save as much as 30% on human capital and associated costs by enlisting freelancers or other types of self-employed workers, according to Business Law Today.
#2 Access to elite talent
Best-in-class workers increasingly opt to work for themselves in order to enjoy the benefits of a flexible work schedule, freedom to set their own rates, and the ability to pick and choose which customers to take on.
Businesses that work with 1099 employees will gain access to this highly desirable pool of talent, which enables them to produce better outcomes.
#3 Greater market agility
With a smaller permanent workforce, businesses are leaner and more agile in the face of unexpected changes or sudden loss of budget. It’s much easier to end a working relationship with a self-employed worker than a full-time employee. On the more positive side of this point, it’s also much faster to dive into work with new freelancers for project-based work than it is to interview, hire, and onboard new employees.
How to classify a 1099 employee?
A worker is considered self-employed if the paying company cannot control or direct how the work is done. To help employers make this determination, the IRS offers three “common law rules” to consider:
- Behavioral: Does the paying company control or have the right to control what the worker does, as well as how the worker does their job?
- Financial: Does the paying company control the business aspects of the worker’s job, such as how the worker is paid, whether their expenses are reimbursed, or who provides equipment/supplies?
- Type of relationship: Is there a written contract? Does the worker receive employee-like benefits from the company, such as a pension plan, insurance, or paid time off? Is the relationship on-going, and is the work performed a key aspect of the business?
Business must review all of these questions when classifying a worker as a 1099 employee or a W-2 employee. Often, the answer isn’t black or white — some factors may indicate a worker is self-employed while others may suggest the relationship is employee-employer.
According to the IRS, “The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.”
The risks of working with self-employed workers
The IRS is not fond of companies that inaccurately classify their workers, especially if they suspect the company may deliberately be doing so to evade taxes. Because this does happen, there are strict penalties in place for companies that misclassify W-2 workers as 1099 employees.
If your company misclassifies workers, even by accident, you could face multiple penalties, fines, back-taxes, and even lawsuits filed against you by the workers themselves. That’s why it’s important to reassess the nature of your relationship to your 1099 workers every six to 12 months to ensure you are in compliance.
Many states have recently become more attuned to the issue of worker misclassification, as well as the implications for self-employed folks who don’t have access to typical employee benefits and protections. That’s what led California to pass the contested Assembly Bill 5 in 2020, and subsequently, Proposition 22.
Should you work with 1099 employees?
By now, you may be asking yourself this question. However, instead of asking if you should work with 1099 employees, you should ask how to do so without creating risk.
In the current business climate, it is difficult for businesses to be agile, fast, and competitive without 1099 employees. Relying exclusively on full-time employees hinders speed and costs more.
In the new reality, businesses are increasingly working with self-employed workers to do a wide range of work. According to Upwork’s Future Workforce Report:
- 73% of hiring managers plan to continue working with or hire more freelancers
- 59% of hiring managers believe that companies that don’t develop a “flexible workforce” are falling behind
Working with independent contractors is a great choice because it provides access to a highly desired pool of talent and allows you to lower overhead costs. And, if you find high-performing workers, you can rely on them to deliver the best results.
As long as you perform your due diligence and don’t try to cut any corners with the IRS, working with 1099 employees is a major advantage.
