An Employer’s Guide to 1099 Employees

Independent contractors bring a wealth of specialized knowledge and experience, allowing your company to scale, adapt to the dynamic demands of new projects, enter new markets, and work efficiently and cost-effectively. Working with an independent contractor can help to create a lean, agile workforce with top-tier talent.

If you plan to work with a 1099 employee, it’s important to know the difference between an independent contractor and a W-2 employee and how you can protect yourself from employee misclassification. The terms 1099 and W-2 come from the paperwork filed with the IRS and U.S. Department of Labor. For example, employers file Form W-2 for every full time employee on their payroll with the IRS.

What is a 1099 contractor?

A 1099 worker is an independent contractor or self-employed person who works with clients instead of being employed by a company or individual. A 1099 contractor may work as a freelancer or operate their own business. 

Key characteristics of a 1099 contractor:

• Sets their own working hours
• Supply their own tools
• Pay their own taxes
• Can deduct business expenses

Working as a 1099 contractor can offer workers more freedom than in standard employment. Clients working with contractors can save money compared to hiring a part- or full-time employee.

How are 1099 employees classified?

Correctly classifying whether someone is an employee or a 1099 contractor is important to ensure you’re paying the right amount of taxes. Both the Internal Revenue Service (IRS) and the Department of Labor (DOL) offer specific guidelines for correctly classifying employees.

IRS classification guidelines

Under IRS guidelines, to determine whether someone is an employee or contractor, you must assess the nature of the relationship, employee behavior, and financial control. 

Some questions you can ask include:

• Behavior control: Does the company control when and how a worker does their job?
• Nature of the relationship: Does the worker receive benefits such as pension, insurance, or paid time off? 
• Financial control: Does the company control how a worker is paid, reimbursement of expenses, and who is providing tools necessary to perform the work?

When determining whether or not someone is an employee, an employer should weigh all of these factors before making a decision. There’s no set amount of factors that determine which category someone will fall in. Some people will have a mixture of factors from both sides. 

To make a final determination, it’s important to look at the relationship as a whole and examine how much control the employer has over the worker.

Department of Labor guidelines

The Department of Labor employs what’s called an economic reality test to assess whether someone is an employee or contractor. This test examines whether someone is economically dependent upon the employer or in business for themselves. 

There are six factors considered in the economic reality test:

1. Opportunity for profit or loss depending on managerial skill
2. Investments by the worker and the employer
3. Permanence of the working relationship
4. Nature and degree of control
5. Whether the work performed is integral to the employer’s business
6. Worker’s skill and initiative

These six factors debuted in 2022 in order to lessen the risk of employee misclassification as more and more workers enter the gig economy and perform work as independent contractors.

1099 employees vs. W2 employees

For both employers and employees, there are benefits and drawbacks to hiring or working as a 1099 contractor or W2 employee.

A 1099 contractor is a self-employed individual or freelancer who works with clients instead of being directly employed by someone. Contractors set their own schedules, provide their own supplies, and manage their taxes and benefits. Contractors will likely have multiple clients at a time and need little to no training to perform the work, being hired as experts in what they do.

A W-2 employee is a full- or part-time employee hired directly by an employer and paid a salary at regular intervals. W-2 employees are on a company's payroll. Employers have more control over a W-2 employee's work hours and workload. The employer provides them with equipment, training, and benefits such as health insurance and retirement.

Pros for 1099 employees

1099 contractors receive a lot of benefits from the flexible working style, which can also provide significant benefits to the clients and companies they work with.

The pros include:

• Flexibility: 1099 employees set their own working hours and schedules. This provides a lot of flexibility for them to work when it’s convenient for them. They also have no set working location, so can work from home, a client’s office space, or anywhere else.
• Specific expertise: Contractors are usually hired as experts in their field, requiring little to no training to get started on the job. The expertise of contractors allows companies to hire someone with a niche talent and the most relevant skills for a specific task. 
• Faster onboarding: Because 1099 workers need minimal training, getting them onboarded and started on the work can take just a few hours instead of the weeks or months it takes for W-2 employees. 
• No need to pay employment taxes or benefits: Independent contractors are responsible for their own benefits and taxes, which can save companies who hire them lots of money.
• Access to foreign markets: Hiring 1099 employees allows a company to build international connections and gain local knowledge. 
• Workforce scalability: The ease of hiring contractors extends to firing them as well. It’s much easier to end a contract with a 1099 worker than a W-2 employee. This means companies can scale up or down depending on their needs.

Cons for 1099 employees

While 1099 employees have a lot more freedom over their time, they also incur the cost of their own benefits and receive fewer legal protections than W-2 employees. Though there are some cons, many of these are risks that can be lessened or eliminated with a well-written contractor agreement.

The cons include:

• Turnover: Neither employers nor contractors must give a set amount of notice that they will stop working together. A termination clause and the length of notification should be determined in the contractor agreement. The term should be equal for both contractor and employer. 
• Misclassification risks: If an employer misclassifies a worker’s employment status, they could face legal fines and liability.
• Intellectual property risks: Unless explicitly stated in the contractor agreement, contractors retain the copyright of any work they produce. As well, hiring a contractor can increase the risk of sensitive or private company information being released. 
• Increased benefits costs: An independent contractor pays their own self-employment tax, which increases their costs of benefits.
• Lack of legal protection: Contractors have fewer rights under federal and state laws. For example, they don’t have the right to minimum wage, overtime pay, or worker’s compensation. 
• Workflow disruption: Because contractors work with multiple clients and are a temporary employee, they may be less invested in the company overall. The rapid turnover in contractors could create workflow disruptions or a contractor may not always be available when desired.

When should businesses hire a 1099 employee?

There are a number of ways that hiring a 1099 contractor can benefit a company. It can save a company money, get someone onboarded and working faster than a W-2 employee, help them to enter a new market, and more. 

When they have short-term projects

A great time to hire a contractor is when your company needs a short-term project completed. 1099 employees can bring in niche expertise and get onboarded quickly to complete a project. Contractors can be hired on a project base, meaning they can work on the project and then no longer work with the company. This can help a company get the project done efficiently without incurring the costs associated with hiring someone full-time.

When a W-2 employee takes a leave of absence

Hiring a contractor when one of your W-2 employees takes a leave of absence can greatly benefit your company. A contractor can come in to manage an employee’s workload for the time that they’re on leave. This allows the company to continue production at the same level without adding workload or stress to their current employees.

When entering a new market

If your company is interested in entering a new market, bringing on a contractor can be a great way to get your foot in the door and build local connections. Hiring an employee in another state or country can create legal and tax complications. Working with a contractor in a different market is simpler and more cost-effective.

When scaling the business

Another period of time where hiring a contractor can benefit your business is when you’re in a period of growth. While scaling your business, you may be looking for ways to stretch each dollar while still encouraging growth. Working with a contractor can be affordable while also bringing in expertise that can work efficiently.

What happens if you misclassify a 1099 worker?

There are many benefits to working with 1099 contractors. When hiring someone as an independent contractor, it’s important to have a strong understanding of the limitations and to create a legally enforceable contractor agreement.

If you misclassify a worker as a contractor when they’re actually a W-2 employee or their work is being controlled as if they were a W-2 employee, you may face penalties or liabilities. A strong contractor agreement can help prevent misunderstanding and misclassification. 

Penalties for misclassifying a W-2 employee as a contractor include:

• $50 fine for each W-2 not filed
• A penalty equal to 3 percent of employee wages and 40 percent of FICA taxes that were not withheld
• 100 percent of all FICA taxes owed must be repaid
• A penalty of up to 25 percent of the total tax liability
• Penalties may also be imposed for unpaid overtime or minimum wage violation

If you’re concerned or uncertain whether a role you’re hiring to fill should be categorized as 1099 or W-2, you can seek guidance from the IRS. You can fill out and submit Form SS-8, Determination of Worker Status. The IRS will review the submitted information and determine the status of your employee. It can take up to six months to receive this final decision.

Why businesses need their own 1099 employee agreements

Employment law varies from state to state and periodically gets updates over the years. With the ins and outs of classifying an employee and the penalties associated with misclassification, it’s important to have a basic understanding of the differences between a 1099 and W-2 employee.

Another protection you can put into place to avoid liability and penalty is to have a legally enforceable, customized 1099 contractor agreement. An experienced lawyer can create a written contract that’s tailored to your company and its needs for a one-time fee.

FAQs

Can 1099 employees work full-time?

A 1099 contractor can work full time or 40 hours a week, but it’s important to recognize that the employer cannot set their schedule or working hours. A 1099 contractor who is working full time for a single company will not receive the employee benefits of a W-2 employee, is not eligible for overtime, and still has the right to work with more than one client. The number of hours a contractor will work should be outlined in the contractor agreement, but there’s no legal maximum cap on hours they may work.

Who pays for a 1099 employee’s taxes?

A 1099 contractor is responsible for filing their taxes, paying self-employment taxes (which covers their social security and Medicare taxes), and income taxes, if applicable. 

How many 1099 employees can a business hire?

There’s no limit to how many 1099 contractors a company can hire.

How do you fire a 1099 employee?

How to end a contract with a 1099 contractor should be laid out in the contractor agreement that was signed when you began working together. There are no legal requirements for terminating a working relationship with a contractor.