W-2 or 1099? The Difference Could Make a Big Difference

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Will you be issuing W-2s or 1099s this year? The deadline for both is February 1, but that's where the similarities end.

If you hire someone for a long-term, full-time project or a series of projects that are likely to last for an extended period, you must pay special attention to the difference between independent contractors and employees. The IRS and Department of Labor are very strict about what a contractor is and isn't. Businesses that incorrectly classify employees as contractors can face steep fines and penalties.

Companies can save a lot of money by hiring independent contractors. Independent contractors are not covered by unemployment and workers' compensation, or by federal and state wage, hour, anti-discrimination, and labor laws. In addition, businesses do not have to pay federal payroll taxes on amounts paid to independent contractors.

So what makes an independent contractor "independent"?

Independent contractors are individuals who contract with a business to perform a specific project or set of projects. You, the payer, have the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result.

Whereas employees provide work in an ongoing, structured basis. In general, anyone who performs services for you is your employee if you can control what will be done and how it will be done. A worker is still considered an employee even when you give them freedom of action. What matters is that you have the right to control the details of how the services are performed.

The IRS, workers' compensation boards, unemployment compensation boards, federal agencies, and even courts all have slightly different definitions of what an independent contractor is though their means of categorizing workers as independent contractors are similar. The infographic below, courtesy of Intuit QuickBooks, provides a quick glance at the three broad categories used by the IRS to determine independent contractor relationships.

Minimize the risk of misclassification.

If you misclassify an employee as an independent contractor, you could end up before a state taxing authority or the IRS.

There are ways to reduce these risks. At a minimum you should:

  • Familiarize yourself with the rules. Not knowing the rules is not a legitimate defense. Knowledge of the rules will enable you to structure and carefully manage your relationships with your workers to minimize risk.
  • Document relationships with your workers and vendors. Although it won't always save you, it helps to have a written contract stating the terms of the employment.

Need help or more information on classifying workers, we'd love to hear from you.