1099 Contractor: Everything You Need to Know
Updated July 8, 2020:
What is a 1099 Contractor?
A 1099 contractor is a person who works independently rather than for an employer. There are significant differences in the legalities of a contractor and employee. While the work can be similar in nature, it is important to follow the law with regard to taxes, payments, and the like.
What Is the Difference Between 1099 and W-2?
Forms 1099 and W-2 are two separate tax forms for two types of workers. Independent contractors use a 1099 form, and employees use a W-2.
For W-2 employees, all payroll taxes are deducted automatically from the paycheck and paid to the government by the employer. Contractors are responsible for paying their own payroll taxes and submitting them to the government on a quarterly basis.
W-2 positions direct employees as to how, when, and where they do a job. Workers who complete tasks or work on individual projects will fall under a 1099. An independent contractor is able to earn a living on his or her own rather than depending on an employer.
Independent contractors are often referred to as consultants, entrepreneurs, business owners, freelancers, or as self-employed individuals. They work for a number of different clients at any given time and are not an employee of any particular company.
The IRS has established certain test to determine if a worker is a contractor or an employee. The independent contractor is considered a separate business and is not considered an employee. If work is considered integral to a business, that person will likely be an employee. Temporary or non-essential work can imply the status of contractor.
What Is the Difference Between a Contractor and an Employee?
Employees, in general, will not have much control over the type of work they will do. However, employees will have benefits and the stability of a full-time job. Health care is often the most sought-after benefit.
A contractor is not entitled to any benefits from an employer. Independent contractors do have more benefits when it comes to taxes. If they use their own tools or materials for the work that they do, they can deduct those expenses from their taxes each year.
How to Determine the Correct Job Status
An independent contractor may:
- Make and keep his or her own schedule.
- Create a certain method to finish assignments.
- Take work as needed or on a case-by-case basis. The contractor may turn down offers if he or she so pleases.
- Will supply his or her own equipment and tools.
- Will have more than one client at a time.
- Can be let go at any time and may choose not to come to work.
- May determine if the work is permanent or temporary.
- Earn a profit or incur a loss from a given task.
- Be paid on a per-job basis.
- Need to invest in all equipment.
- Have to pay for business and traveling expenses as needed.
- Hire and pay assistants.
An employee may:
- Have a set schedule of assigned hours.
- Receive training from the company.
- Be provided with all the tools needed to finish work.
- Be required to complete all work assigned by the employer.
- Have only one employer.
The following questions will determine the type work relationship:
- How much control of the work is involved and who is in charge of that control?
- What is the level of loss for every party in the relationship?
- Who pays for all supplies and materials used for work?
- Is the worker an essential part of the business?
- What is the degree, if any, of permanence?
Is a Contractor Required to Pay Income Taxes on Income?
Just like anyone else who works, an independent contractor does have to pay income tax. Contractors do not have taxes taken out of their paychecks to cover Social Security and Medicare. Also, independent contractors cannot wait until April 15 to pay all taxes due for the previous year. Instead, independent contractors will need to pay quarterly estimated taxes. However, there are some great tax deductions available to contractors.
How Much Should Contractors Charge for Their Services?
Each independent contractor may come up with an amount that will pay for all of his or her expenses. The figure must also compensate the contractor for his or her time and expertise and should provide some profit.
However, it is very important that the contractor not charge more than the market rate for any particular job.
How Can Contractors Ensure They Will Be Paid?
While doing the work is very important, it is equally important that the contractor be paid. If a client will not pay after being invoiced, the contractor can pursue payment via legal options.
Are Written Agreements Necessary?
It is ideal to use a written agreement before performing any work for a client or employer. This will help to avoid any disputes by outlining the description of the services to be performed. This agreement should clearly state what tasks the contractor is to perform. The agreement will also include what tasks will be performed and how much the contractor will be paid for his or her work.
A contractor agreement can also help demonstrate that the person is truly an independent contractor and not an employee. It also shows the IRS that the contractor and the hiring firm are embarking on an independent contractor relationship.
Who Makes Decisions on Classification?
The hiring firm will determine how the worker will be classified within the company. The worker can be classified either as an independent contractor or an employee.
The IRS and other government agencies will ultimately make the decision should it come up for review. The IRS will take many factors into account when deciding if you are an employee or an independent contractor.
Advantages to Self-Employment
There are a variety of advantages of self-employment:
- You are your own boss.
- You can potentially be paid more than regular employees.
- You will not have any federal or state tax withheld from your pay.
- You can take many business deductions on your taxes.
Disadvantages of Self-Employment
There also are some disadvantages of self-employment:
- You may lack job security.
- You have the possibility of not getting paid.
- You must pay your own self-employment taxes.
- You are personally liable for all business debt.
- You will have no employer-provided benefits.
- You don’t receive unemployment insurance benefits.
- You have no workers' compensation coverage.
- You will have very few protections from labor laws.
Employer Tax Liability
Tax liability of an employer is decided by the worker's employment status. When a worker is an employee, he or she must pay all state and federal unemployment tax. The employee is also responsible for paying Social Security tax, workers' compensation premium, and disability premiums to a state insurance fund.
If the worker is a contractor, the hiring entity will not be required to make these payments.
If an employer does not define a worker correctly, they can be held liable for any past due taxes, including federal unemployment tax and FICA.
Supreme Court Decisions Relating to Independent Contractor Status
The Supreme Court has made decisions that relate to the status of an independent contractor, such as:
- How essential the services rendered are to the business.
- How permanent the working relationship is.
- The sum of the contractor’s investment in equipment and materials.
- The contractors' opportunity for profit and loss.
- The amount of independence the contractor has from a business organization.
How Does the IRS Decide a Worker's Status?
There are three general criteria set up by the IRS. They are:
- Behavioral control
- Financial control
- Relationship type
Behavioral control. An employer trains and directs the work including the amount of hours worked, the tools used for the job, certain tasks that are be completed, and how the work is to be done. If this is the case, the person is an employee. A worker that sets his or her own hours and works with no direction or training is considered to be an independent contractor.
Financial control. This determines how the worker is paid. It also includes whether or not the worker can work for other people at the same time and if the worker can take a loss or profit.
Type of relationship. If there is a specific contract in the relationship, it may indicate one is an independent contractor. However, workers who are entitled to benefits are usually considered employees.
Two Restrictive Covenants to Consider When Hiring an Independent Contractor
A non-solicitation agreement prevents the worker from soliciting your customers or employees from your business. Also, a non-disclosure agreement will prevent the worker from disclosing any and all trade secrets or proprietary information of current or former employers.
Check Credentials Before Hiring an Independent Contractor
A background check needs to be performed to review a person’s commercial, financial, and criminal records. Surveys show that up to 70 percent of employers will require an employee to have a background check completed before being hired.
However, an employer may not use any background information provided in a background check to discriminate against anyone. The employer has to request a background check for every applicant. Not doing so can be discriminatory. It would not be legal, for example, to check the criminal records of all male applicants but not female applicants.
The employer can perform a background check to find out if the worker officially graduated from college. This will also help confirm any job history that is included on an application. Background checks can also protect the employer from any liability issues that may arise.
Paying an Independent Contractor
It's quite easy to pay an independent contractor. The payment type in process should be outlined in the independent contractor agreement.
Hourly. Some contractors choose to be paid on an hourly basis. This can include those who do computer programming.
By the job. Contractors may also be paid by the job. The contractor will receive a set rate for each task completed.
Although a verbal contract is legal, it is always best to outline all of the details in a written contract. This will prevent any misunderstanding between both parties.
The contract should state how often payment is due, whether or not there are any milestones for payment, and all specific deadlines needed for the job.
Once the job is done, and a deadline is met, the pay is to be given to the contractor. There can be some concerns on the part of the hiring party with regard to paying the contractor, such as:
- What if work is not completed within the agreed time frame?
- What if the payments cannot be made in a timely fashion?
- What if the quality of work is not good?
All of these terms are just as important as any other aspect of a contract and must be determined prior to the start of work. There will be no federal or state income tax withheld from any portion of payment to an independent contractor.
IRS Backup Withholding Notice
Backup withholding is required for non-employees, which include independent contractors. The employer may not withhold income taxes from a non-employee unless the contractors’ taxpayer ID number is unable to be verified.
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