Understanding 1099 Status and Worker Classification

Key Takeaways

• 1099 status applies to independent contractors who operate as self-employed professionals.
• Employers must follow IRS rules when classifying workers to avoid costly misclassification penalties.
• Independent contractors maintain control over how, when, and where work is performed.
• 1099 contractors are responsible for their own taxes and may need to make quarterly estimated payments.
• Misclassification of employees as 1099 contractors can result in fines, lawsuits, and back payments.
• New content expands on benefits, drawbacks, and legal tests used to determine worker classification.

1099 status refers to an individual’s status as a self-employed contractor or business owner for whom a 1099 form must be filled out for by the contracting party and filed with the IRS. The 1099 form records the amount of money paid out to the contracted party and is thus a means for the IRS to keep track of the income of self-employed individuals as well as where certain taxes should be coming from. Companies that attempt to deceive the IRS as to the status of their workers may meet with serious consequences.  

1099 Employer Responsibilities

A company contracting 1099 workers must meet the following responsibilities:

1. Report pay to 1099 workers on a 1099 form to the IRS.
2. Keep accurate records of the payment amounts and payment dates.
3. Provide a 1099 form to the contractor by the final day of January that details the work they performed in the previous year.

1099 Contractor Responsibilities

1099 contractors have their own responsibilities to meet concerning their status, and those are:

1. To pay all taxes, including Medicare and Social Security payments, to the IRS.
2. In some cases, make quarterly income estimates and submit them to the IRS.

Benefits and Drawbacks of 1099 Status

Understanding the advantages and disadvantages of 1099 status is critical for both businesses and contractors.

Benefits for Contractors:

• Greater flexibility in setting hours and choosing clients
• Control over how work is completed
• Potential tax deductions for business-related expenses
• Opportunity to work with multiple clients and increase income streams

Drawbacks for Contractors:

• No access to employer-provided benefits such as health insurance, paid leave, or retirement plans
• Responsible for self-employment tax and recordkeeping
• May face income instability due to fluctuating client work

Benefits for Employers:

• No obligation to pay employment taxes, benefits, or unemployment insurance
• Reduced administrative burden compared to managing employees

Drawbacks for Employers:

• Less control over the contractor’s day-to-day activities
• Higher turnover or inconsistency in contractor availability
• Risk of misclassification and associated legal exposure

1099 Status Qualifications

There are strict IRS guidelines as to what can be considered a self-employed contractor, and these are:

1. The company cannot control how the worker performs their job.
2. The company cannot control financial details related to the job.
3. The company cannot offer worker benefits, such as paid vacations, a retirement plan, or health insurance.

In sum, the question of whether a worker is a self-employed contractor or not comes down to whether a company can exert behavioral, financial, or relational control over the worker. If a worker’s status is still in doubt, the following questions may be considered:

• Does the worker determine their schedule and work location?
• Does the worker receive training from the employer?
• Does the worker have employees?
• Does the worker determine the sequence of the service they give?
• Does the worker determine the reporting they will give the company?
• Does the worker submit invoices?
• Does the worker pay for their own travel and business expenses?
• Does the worker provide their own materials and tools?
• Does the worker run their own business?
• Does the worker run advertising for themselves?
• Does the worker have multiple clients?
• Does the worker provide their own insurance?
• Does the worker have a temporary or open-ended relationship with the company?

If the majority of these questions can be answered in the affirmative, then more likely than not, the worker is a self-employed contractor.

Legal Tests to Determine 1099 Status

The IRS uses several tests to determine whether a worker should be classified as an independent contractor. One of the most important is the Common Law Test, which evaluates three categories:

1. Behavioral Control – Does the company control how the worker does the job?
2. Financial Control – Does the business control the financial aspects, such as method of payment and expense reimbursement?
3. Type of Relationship – Are there written contracts or benefits like health insurance? Is the relationship ongoing?

Other tests used by state agencies or courts may include:

• The ABC Test, used in states like California, where a worker is considered an employee unless the hiring entity proves:
  • The worker is free from control and direction in performing the work.
  • The work performed is outside the usual course of the business.
  • The worker is engaged in an independently established trade.

These tests vary by jurisdiction and can influence unemployment insurance eligibility and wage claims.

1099 Employee Misclassification Consequences

The determination of whether a worker has 1099 status should be considered carefully and made correctly because the consequences of misclassification can be quite severe. If a company classifies an employee as an independent contractor rather than an employee, the consequences can include:

• The employer being required to pay all the taxes that were required to be withheld, in addition to a penalty fine.
• The state government seeking unemployment insurance and workers’ compensation insurance premiums that ought to have been paid.
• The worker pursuing legal action to receive compensation for payroll tax contributions, employee benefits, and overtime.

Some companies attempt to skirt the line on independent contractor work for employees, while others are actively deceptive, since there may be significant savings in avoiding hiring salaried employees. In fact, it is estimated that 20 percent of businesses have misclassified workers intentionally or unintentionally. Because of this high number of misclassification and the money that can be saved fraudulently by doing so, the consequences of being caught are designed to be even more costly. For example:

• The Orange County Register was forced to pay $22 million in a suit involving workers being misclassified as independent contractors.
• Three construction companies were ordered by the Department of Labor to pay $491,000 in damages and back pay, along with another $108,000 in civil fines, due to worker misclassification.
• A major shipping company was fined $319 million by the IRS and ordered to pay $27 million by a court due to worker misclassification.

How to Avoid Misclassification

To avoid the steep penalties associated with misclassification, employers should take the following proactive steps:

• Use Written Agreements: Draft contracts that outline the nature of the relationship, emphasizing independent control and payment structure.
• Evaluate Work Scope: Ensure the contractor’s duties do not mirror those of a regular employee.
• Conduct Regular Audits: Review roles and responsibilities periodically to ensure they align with the contractor classification.
• Seek Legal or Tax Advice: Consult with professionals familiar with IRS and state classification rules.

Using government tools like the IRS Form SS-8 can also help determine a worker’s correct status when in doubt.

Frequently Asked Questions

1. What is 1099 status?
   It refers to a worker being classified as an independent contractor who receives a 1099 form instead of a W-2 and is responsible for self-employment taxes.
2. What are the risks of misclassifying a 1099 contractor?
   Businesses may face IRS penalties, back taxes, lawsuits, and fines if a worker is wrongly classified as a contractor instead of an employee.
3. How can you determine if a worker qualifies for 1099 status?
   Look at the degree of control over how and when work is done, the financial relationship, and whether the worker operates independently.
4. Do 1099 workers get benefits?
   No. Independent contractors typically do not receive benefits such as health insurance, paid time off, or retirement contributions from clients.
5. Can a 1099 contractor work for only one client?
   Yes, but having only one client may raise red flags for the IRS if the contractor is functionally treated like an employee.

It is best not to risk worker misclassification, even if you have no intent to deceive. If you need help understanding 1099 status, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.