A 1099 employee is a US self-employed worker that reports their income to the IRS on a 1099 tax form. Freelancers, gig workers, and independent contractors are all considered 1099 employees.
In contrast, actual company employees are considered W-2 employees. At the end of each year, companies are required to send a W-2 form (also known as the Wage and Tax Statement), to each employee, as well as to the IRS on employees’ behalf. The W-2 states an employee’s annual wages and the amount of taxes withheld from their paychecks.
Unlike W-2 employees, self-employed workers are responsible for reporting their own income and paying their own self-employment taxes, which cover Social Security and Medicare. They are not defined as employees legally, therefore the term 1099 employees is quite problematic.
Here’s a breakdown of 1099 ’employees’ and what you need to know if you’re considering hiring them.
This is part of an extensive series of guides about compliance management.
Who needs to file a 1099 tax form?
Any self-employed individual who earns a total of $400 or more from all of their clients in one year is required to report their income to the IRS and pay taxes on it. The IRS considers a worker to be self-employed if they meet any of the following criteria:
- They perform a trade or business as a sole proprietor or an independent contractor
- They are a member of a partnership that carries on a trade or business
- They are otherwise in business for themselves, including part-time work
What are the different categories of 1099 employees?
As self-employment rises in popularity, a variety of definitions have emerged to distinguish the different natures of work. All of the following titles can be considered 1099 employees.
- Freelancer — An individual who earns money by the job, task, or hour, usually for short-term work. Freelancers often work with multiple clients simultaneously, unless contracted to work exclusively for one company.
- Gig worker — Someone who performs temporary, flexible jobs, often through an online app or platform. Uber, Lyft, Instacart, and other driver-based companies operate on gig worker labor.
- Crowd workers — Also known as crowdsourcing or platform work, crowd work refers to the outsourcing of tasks to a large pool of online workers via an online platform, rather than to a single worker or employee.
Outsource teams — Third-party or external teams that are not part of your organization may be enlisted to perform tasks, handle operations, or provide services to a paying company.
The 3 advantages of hiring 1099 employees
Here are the three main advantages of working with 1099 employees over W-2 employees.
#1 Lower business expenses
Unlike regular W-2 employees, paying companies are not required to pay taxes on behalf of self-employed workers, contribute to workers’ comp or unemployment insurance on their behalf, or provide health benefits. Companies are not subject to a minimum wage limit or overtime regulation, nor do they need to provide sick days or retirement benefits.
At the end of the day, businesses can save as much as 30% on human capital and associated costs by enlisting freelancers or other types of self-employed workers, according to Business Law Today.
#2 Access to elite talent
Best-in-class workers increasingly opt to work for themselves in order to enjoy the benefits of a flexible work schedule, freedom to set their own rates, and the ability to pick and choose which customers to take on.
Businesses that work with 1099 employees will gain access to this highly desirable pool of talent, which enables them to produce better outcomes.
#3 Greater market agility
With a smaller permanent workforce, businesses are leaner and more agile in the face of unexpected changes or sudden loss of budget. It’s much easier to end a working relationship with a self-employed worker than a full-time employee. On the more positive side of this point, it’s also much faster to dive into work with new freelancers for project-based work than it is to interview, hire, and onboard new employees.
How to classify a 1099 employee?
A worker is considered self-employed if the paying company cannot control or direct how the work is done. To help employers make this determination, the IRS offers three “common law rules” to consider:
- Behavioral: Does the paying company control or have the right to control what the worker does, as well as how the worker does their job?
- Financial: Does the paying company control the business aspects of the worker’s job, such as how the worker is paid, whether their expenses are reimbursed, or who provides equipment/supplies?
- Type of relationship: Is there a written contract? Does the worker receive employee-like benefits from the company, such as a pension plan, insurance, or paid time off? Is the relationship on-going, and is the work performed a key aspect of the business?
Business must review all of these questions when classifying a worker as a 1099 employee or a W-2 employee. Often, the answer isn’t black or white — some factors may indicate a worker is self-employed while others may suggest the relationship is employee-employer.
According to the IRS, “The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.”
The risks of working with self-employed workers
The IRS is not fond of companies that inaccurately classify their workers, especially if they suspect the company may deliberately be doing so to evade taxes. Because this does happen, there are strict penalties in place for companies that misclassify W-2 workers as 1099 employees.
If your company misclassifies workers, even by accident, you could face multiple penalties, fines, back-taxes, and even lawsuits filed against you by the workers themselves. That’s why it’s important to reassess the nature of your relationship to your 1099 workers every six to 12 months to ensure you are in compliance.
Many states have recently become more attuned to the issue of worker misclassification, as well as the implications for self-employed folks who don’t have access to typical employee benefits and protections. That’s what led California to pass the contested Assembly Bill 5 in 2020, and subsequently, Proposition 22.
Should you work with 1099 employees?
By now, you may be asking yourself this question. However, instead of asking if you should work with 1099 employees, you should ask how to do so without creating risk.
In the current business climate, it is difficult for businesses to be agile, fast, and competitive without 1099 employees. Relying exclusively on full-time employees hinders speed and costs more.
- 73% of hiring managers plan to continue working with or hire more freelancers
- 59% of hiring managers believe that companies that don’t develop a “flexible workforce” are falling behind
Working with independent contractors is a great choice because it provides access to a highly desired pool of talent and allows you to lower overhead costs. And, if you find high-performing workers, you can rely on them to deliver the best results.
As long as you perform your due diligence and don’t try to cut any corners with the IRS, working with 1099 employees is a major advantage.
See Our Additional Guides on Key Compliance Management Topics
Together with our content partners, we have authored in-depth guides on several other topics that can also be useful as you explore the world of compliance management.
- AB5 Updates: Where Does the Original Legislation Stand Now?
- AB2257: Another Significant Update to California’s AB5
- Proposition 22: What Is It and What Are Its Ramifications?
- Worker Classification: The How-To Playbook
- FLSA Classification: Who is Exempt and Why Do You Need to Know?
- Employee Misclassification 101: What You Need to Know