What are the requirements for independent contractors (1099 workers)?
Answer: Independent contractors pay their own payroll taxes and insurances, including workers’ compensation, and are not covered by many labor laws, so the financial and administrative benefits of having a workforce composed of independent contractors can be significant. However, it is crucial for business owners to understand that independent contractor status is not an arbitrary election but is based on the job structure. It is also important to understand that independent contractor status cannot be established or supported by the completion of any particular forms or tax paperwork (like Form 1099-MISC), the drafting of a carefully worded offer letter or an independent contractor agreement, a piece work, commission, or other performance-based compensation method or by part-time, seasonal or other short-term work arrangements.
Misclassifying workers as contractors can have labor law, employee benefits, employment tax, and workers’ compensation implications for businesses and the affected workers. For example, making the wrong determination of a worker’s status can result in IRS and state tax audits with back tax assessments that can be ruinous to a small business; therefore, it is important that a business owner understand the criteria that the IRS and state authorities use in determining whether a worker is properly classified as an employee or an independent contractor. To develop a better understanding of the risks, you can review discussions on the topic at websites like the following:
- Misclassifying Workers Can Cost You, Big Time: inc.com
- Proceed With Caution When Using Independent Contractor Status: metrocorpcounsel.com
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Whether a particular worker qualifies as an independent contractor with regard to the services provided your business will depend on all the facts and circumstances. An independent contractor is a legal category of worker defined by the Internal Revenue Service. The basic difference between an independent contractor and an employee under the IRS definition is that, unlike employees, independent contractors retain control over how the work they are hired to do gets done; the person or company paying the independent contractor controls only the outcome – the product or service. With an employee, by contrast, the person or company paying an employee controls not only the outcome of the employee’s work, but also how the work they do gets done. In order to determine whether a worker qualifies as an independent contractor rather than an employee, the worker’s job and the control you exert over the worker must be evaluated under what is known as the common law right of control test. Under this subjective test, for which the IRS developed a 20-factor analysis for its auditors, the IRS basically takes the position that if you tell a worker what to do and how to do it, then that worker is an employee. To add to the classification difficulty, state government agencies often use different criteria than the IRS for classifying workers as employees or independent contractors for state tax and workers’ compensation purposes and some states can impose severe penalties under state law on businesses that misclassify workers as independent contractors. Since the potential penalties for misclassifying a worker as a contractor rather than an employee can be severe, you should clarify that a worker’s job meets the IRS criteria for independent contractor status before engaging the worker.
Again, if you are uncertain about the proper classification of your workers, you should review the details of their responsibilities with your lawyer to assure that you handle the compensation, payroll taxes, and insurance in accordance with labor and tax regulations. You can review general discussions about independent contractors and hiring workers at the following websites:
- Using Independent Contractors & Freelancers: nolo.com
- Employer Resource Center: entrepreneur.com
- Independent Contractor (Self-Employed) or Employee: irs.gov
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You can also review more in depth discussions at the following IRS websites:
- Employer’s Supplemental Tax Guide 2013: irs.gov (see 2. Employee or Independent Contractor?)
- Independent Contractor or Employee? irs.gov
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Contractor agreements: Regardless of the business structure, it is advisable to have written agreements with qualified independent contractors to explain the job responsibilities, compensation arrangements, tax and insurance responsibilities, and other important terms of the arrangement.
Businesses typically have insurance provisions in written independent contractor agreements that explain the required insurance coverage (liability, workers compensation, bond, etc) and that require contractors to provide a Proof of Insurance Form that demonstrates that they have the insurance required under the contract. In addition, it is advisable for businesses that use independent contractors to obtain the proper liability insurance coverage to protect themselves from the actions of contractors who fail to maintain the required insurance or are otherwise named in legal actions involving their contractors. You should consult your business insurance agent to determine the recommended insurance coverage and other risk management implications when engaging independent contractors.
For drafting and review with your lawyer, you can find templates for Independent Contractor and Consulting Agreements in the Legal Resources section of your GSB Account under Customizable Letters & Forms then the Labor & Employment category. Also, you can find sample independent contractor and other agreements (some free and others for a fee) that you may be able to use in your situation at websites like the following:
- Sample Independent Contractor Agreement: inc.com
- Sample Independent Contractor Agreement: steppingstonetutors.com
- Independent Contractor Agreement: ilrg.com
- Independent Contractor Agreement Forms: uslegalforms.com
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Contractor tax reporting:
Form 1099-MISC: Under current tax law, businesses report cash and check payments for services rendered by non-corporate vendors, such as qualified independent contractors, on Form 1099-MISC, which is filed annually and, in the case of services, only when payments total $600 or more during the calendar year. Businesses are required to provide non-corporate vendors with copies of Form 1099-MISC for the preceding calendar year by January 31st.
Copies of Forms 1099-MISC also must be submitted to the IRS and certain state taxing authorities for the preceding calendar year by February 28th; however, most states obtain their 1099 information through data sharing arrangements with the IRS. Forms 1099-MISC submitted to the IRS must be accompanied by Form 1096, Annual Summary and Transmittal of U.S. Information Returns. Forms 1099-MISC and 1096 must be submitted to the IRS electronically or using machine readable (optically scanned) forms that you can order directly from the IRS at 1-800-TAX-FORM (1-800-829-3676). You can find and review Forms 1099-MISC, 1096 and the filing instructions at the following IRS websites:
- Form 1099-MISC, Miscellaneous Income: irs.gov
- Form 1096, Annual Summary and Transmittal of US Information Returns: irs.gov
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Form 1099-K: It is important to note that beginning with the 2011 tax year, businesses only report cash or check payments on Form 1099-MISC.
Payments made by credit or debit cards as well as those made through third-party networks such as PayPal, Amazon.com and Google are reported by the payment processors on new Form 1099-K. You can review the changes at the following articles:
- Understanding the New Form 1099-K: fusiontaxes.com
- Reporting Requirement for Merchant Card & Third-Party Network Payments: bkd.com
- 1099-K Reporting Requirements for Payment Settlement Entities: irs.gov
- Form 1099-K Payment Card and Third Party Network Transactions: irs.gov
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However, the regulations contain an “aggregate payee” rule that requires companies who accept credit or debit card payments and third party network payments for other parties who work for them as independent contractors to report those payments on Form 1099-K. You can review Form 1099-K and its instructions at the following website:
Form W-9: The basic tool to properly identify and manage your Form 1099 reporting and potential tax withholding obligations with vendors is Federal Form W-9, Request for Taxpayer Identification Number and Certification. FormW-9 is used by businesses to obtain a vendor’s, including an independent contractor’s TIN or Taxpayer Identification Number (Social Security Numbers in the case of an individual or Federal Employer Identification Number (EIN) for a business) and to have the vendor certify that they are not subject to backup withholding. When a vendor fails to provide you with a TIN, you will be required to withhold federal income tax from your payments to that vendor under the backup withholding rules. For 2013 the backup withholding rate is 28%. You can locate Form W-9 and instructions and review the backup withholding rules at the following IRS websites:
Form W-9:
- Request for Taxpayer Identification Number and Certification: irs.gov
- Instructions for the Requester of Form W-9: irs.gov
-
Backup withholding:
- Misclassifying Workers Can Cost You, Big Time: inc.com
- Proceed With Caution When Using Independent Contractor Status: metrocorpcounsel.com
Whether a particular worker qualifies as an independent contractor with regard to the services provided your business will depend on all the facts and circumstances. An independent contractor is a legal category of worker defined by the Internal Revenue Service. The basic difference between an independent contractor and an employee under the IRS definition is that, unlike employees, independent contractors retain control over how the work they are hired to do gets done; the person or company paying the independent contractor controls only the outcome – the product or service. With an employee, by contrast, the person or company paying an employee controls not only the outcome of the employee’s work, but also how the work they do gets done. In order to determine whether a worker qualifies as an independent contractor rather than an employee, the worker’s job and the control you exert over the worker must be evaluated under what is known as the common law right of control test. Under this subjective test, for which the IRS developed a 20-factor analysis for its auditors, the IRS basically takes the position that if you tell a worker what to do and how to do it, then that worker is an employee. To add to the classification difficulty, state government agencies often use different criteria than the IRS for classifying workers as employees or independent contractors for state tax and workers’ compensation purposes and some states can impose severe penalties under state law on businesses that misclassify workers as independent contractors. Since the potential penalties for misclassifying a worker as a contractor rather than an employee can be severe, you should clarify that a worker’s job meets the IRS criteria for independent contractor status before engaging the worker.
- Using Independent Contractors & Freelancers: nolo.com
- Employer Resource Center: entrepreneur.com
- Independent Contractor (Self-Employed) or Employee: irs.gov
You can also review more in depth discussions at the following IRS websites:
- Employer’s Supplemental Tax Guide 2013: irs.gov (see 2. Employee or Independent Contractor?)
- Independent Contractor or Employee? irs.gov
Contractor agreements: Regardless of the business structure, it is advisable to have written agreements with qualified independent contractors to explain the job responsibilities, compensation arrangements, tax and insurance responsibilities, and other important terms of the arrangement.
Businesses typically have insurance provisions in written independent contractor agreements that explain the required insurance coverage (liability, workers compensation, bond, etc) and that require contractors to provide a Proof of Insurance Form that demonstrates that they have the insurance required under the contract. In addition, it is advisable for businesses that use independent contractors to obtain the proper liability insurance coverage to protect themselves from the actions of contractors who fail to maintain the required insurance or are otherwise named in legal actions involving their contractors. You should consult your business insurance agent to determine the recommended insurance coverage and other risk management implications when engaging independent contractors.
For drafting and review with your lawyer, you can find templates for Independent Contractor and Consulting Agreements in the Legal Resources section of your GSB Account under Customizable Letters & Forms then the Labor & Employment category. Also, you can find sample independent contractor and other agreements (some free and others for a fee) that you may be able to use in your situation at websites like the following:
- Sample Independent Contractor Agreement: inc.com
- Sample Independent Contractor Agreement: steppingstonetutors.com
- Independent Contractor Agreement: ilrg.com
- Independent Contractor Agreement Forms: uslegalforms.com
Contractor tax reporting:
Form 1099-MISC: Under current tax law, businesses report cash and check payments for services rendered by non-corporate vendors, such as qualified independent contractors, on Form 1099-MISC, which is filed annually and, in the case of services, only when payments total $600 or more during the calendar year. Businesses are required to provide non-corporate vendors with copies of Form 1099-MISC for the preceding calendar year by January 31st.
Copies of Forms 1099-MISC also must be submitted to the IRS and certain state taxing authorities for the preceding calendar year by February 28th; however, most states obtain their 1099 information through data sharing arrangements with the IRS. Forms 1099-MISC submitted to the IRS must be accompanied by Form 1096, Annual Summary and Transmittal of U.S. Information Returns. Forms 1099-MISC and 1096 must be submitted to the IRS electronically or using machine readable (optically scanned) forms that you can order directly from the IRS at 1-800-TAX-FORM (1-800-829-3676). You can find and review Forms 1099-MISC, 1096 and the filing instructions at the following IRS websites:
- Form 1099-MISC, Miscellaneous Income: irs.gov
- Form 1096, Annual Summary and Transmittal of US Information Returns: irs.gov
Form 1099-K: It is important to note that beginning with the 2011 tax year, businesses only report cash or check payments on Form 1099-MISC.
Payments made by credit or debit cards as well as those made through third-party networks such as PayPal, Amazon.com and Google are reported by the payment processors on new Form 1099-K. You can review the changes at the following articles:
- Understanding the New Form 1099-K: fusiontaxes.com
- Reporting Requirement for Merchant Card & Third-Party Network Payments: bkd.com
- 1099-K Reporting Requirements for Payment Settlement Entities: irs.gov
- Form 1099-K Payment Card and Third Party Network Transactions: irs.gov
However, the regulations contain an “aggregate payee” rule that requires companies who accept credit or debit card payments and third party network payments for other parties who work for them as independent contractors to report those payments on Form 1099-K. You can review Form 1099-K and its instructions at the following website:
Form W-9: The basic tool to properly identify and manage your Form 1099 reporting and potential tax withholding obligations with vendors is Federal Form W-9, Request for Taxpayer Identification Number and Certification. FormW-9 is used by businesses to obtain a vendor’s, including an independent contractor’s TIN or Taxpayer Identification Number (Social Security Numbers in the case of an individual or Federal Employer Identification Number (EIN) for a business) and to have the vendor certify that they are not subject to backup withholding. When a vendor fails to provide you with a TIN, you will be required to withhold federal income tax from your payments to that vendor under the backup withholding rules. For 2013 the backup withholding rate is 28%. You can locate Form W-9 and instructions and review the backup withholding rules at the following IRS websites:
Form W-9:
- Request for Taxpayer Identification Number and Certification: irs.gov
- Instructions for the Requester of Form W-9: irs.gov
Backup withholding:
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