I speak to potential clients who often state that they are paid as a “1099 employee.” There is no such category. In fact, the term 1099 and employee are two distinct categories and cannot live together.
If you are paying your employee as a contractor or you are being paid as a contractor but are really an employee, that is illegal.
Often, businesses do this as a cost cutting measure. From time to time, a business may do this because they have made an honest mistake. While this practice may seem like a simple solution for some businesses, it can quickly turn into a recipe for disaster.
The misclassification of employees can lead to a host of legal and financial problems for businesses, including hefty fines, lawsuits, and damage to their reputation. Moreover, it can result in significant financial consequences for misclassified employees who may be denied important benefits and protections.
What Is the Difference Between Paying an Employee and Paying a Contractor?
In the United States, there is a legal distinction between employees and independent contractors, and businesses must be aware of the differences when determining how to pay their workers.
An employee is a person who performs services for an employer and is subject to the employer’s control and direction. Employees are typically provided with the tools and equipment necessary to perform their job, and they receive training and supervision from their employer. Employers are required to withhold and pay payroll taxes, social security, and Medicare taxes for their employees, and they may also be required to provide perks such as health insurance, time off, and retirement plans. What an employer is required to provide will vary from State to State.
Paying an Independent Contractor
On the other hand, an independent contractor is a person who performs services for a business but is not under the employer’s control and direction. Independent contractors typically have their own tools and equipment and are responsible for their own training and supervision.
They are paid a fee for their services and are responsible for paying their own taxes, including self-employment taxes. Independent contractors are not entitled to benefits from the business for which they work.
There are many factors to balance out in determining whether one is an independent contractor, as opposed to an employee.
The distinction between employees and independent contractors is important because it determines how workers are paid, what taxes must be withheld, and what benefits they are entitled to receive. Misclassifying employees as independent contractors can manifest in legal and financial consequences for businesses, as they may be held liable for unpaid taxes and benefits.
In order to determine whether a worker is an employee or an independent contractor depends on a balancing of various factors. The U.S. Department of Labor, the Internal Revenue Service (IRS) and state labor agencies will balance out the factors to determine whether one falls on the side of being an employee. These factors consider the worker’s degree of control over their work, the type of work they perform, and whether they are integrated into the employer’s business, among others.
Legal and Regulatory Risks
Paying employees as contractors can lead to legal and regulatory risks for both the employer and the employee.
One significant risk is misclassification, where an employee is classified as an independent contractor to avoid certain tax and legal obligations. Misclassification can lead to lawsuits, fines, and penalties from government agencies, such as the Internal Revenue Service (IRS) and the Department of Labor (DOL).
Employers may also face lawsuits from employees seeking benefits and protections that are only available to employees, such as workers’ compensation, unemployment insurance, and healthcare benefits.
Another risk is noncompliance with wage and hour laws. Contractors are typically paid a flat fee or an hourly rate, but they are not entitled to overtime pay or minimum wage protections. However, employees are entitled to these protections under federal and state laws. If an employer incorrectly classifies an employee as a contractor, they may be liable for unpaid wages, overtime pay, and other benefits.
Paying employees as contractors also carries financial risks for both parties. Contractors are responsible for paying their own taxes, including self-employment taxes, which are higher than payroll taxes. This means that contractors receive gross pay, which they must use to pay taxes and other expenses such as healthcare and retirement savings.
On the other hand, employees receive net pay, which has already been taxed and includes benefits and other deductions. Employers who misclassify employees as contractors may also face back taxes, penalties, and interest from the IRS and state tax agencies. Additionally, employers may have to pay for employee benefits and other expenses retroactively, which can be costly.
Seek Legal Counsel
If you have been paid as an independent contractor and you should have been paid as an employee, seek legal counsel as you may be owed wages and other benefits.
If you have paid your employees as contractors and you are facing legal action, regulatory action, or simply want to institute correct procedures, it is important to seek legal counsel to defend or assist you.