There has been a recent boom in hiring independent contractors, specifically 1099 employees, due to the communications revolution and workplace mobilization. Individuals can now easily connect with potential clients and quickly deliver work.
Being an independent contractor lets individuals run their own businesses, offering desirable freedom and flexibility. With the rise of short-term projects and ever-changing workflows, many businesses are considering adding contractors to their workforce.
What Is a 1099 Employee?
A 1099 employee is an independent contractor or a freelancer. 1099 refers to the forms that contractors receive from the companies that hire them. When a business hires an independent contractor, it is comparable to the contractor signing a contract with a business. The individual and company work together to decide on an agreeable rate. The business then outsources the service or project to the contractor.
Here are five things you need to know before hiring a 1099 employee.
1. What Are the Potential Cost Savings?
Because hiring a 1099 employee is comparable to contracting the work to another business, the employer is not responsible for as many expenses as a full-time employee. Some of the things businesses can avoid paying by using a 1099 employee include:
- Taxes, social security, unemployment insurance, or workers compensation insurance
- Equipment or office space for a freelancer
- Expensive training
- Long-term commitments or contracts
2. What Constitutes a 1099 Employee?
To determine if a worker is an employee or contractor, the IRS uses a simple method that focuses on the following three factors:
- Behavioral control. Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial control. Does the business control different monetary aspects or benefits of the worker’s job (i.e., method of payment, reimbursement of expenses, etc.)?
- Type of relationship. Are there written contracts or employee-type benefits (i.e., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
3. Incorrectly Classifying a Worker Can Cost You
Because the classification categories are complex, the answer is not always clear-cut. However, there is a huge legal risk for misclassifying a worker as a contractor if he/she is actually operating as a regular employee.
This is especially daunting if you’re in a new country without a legally established entity. If a dispute occurs with your contractor and he/she wins in court, your business must have a legally established entity in your new country, and you may owe that contractor backdated withholdings, which include payments into their social security and pensions. If labor courts suspect that there was intentional misclassification, there are additional fines and payments due to the employee.
Additionally, misclassified workers can sue if they were owed overtime pay or were paid below minimum wage. For example, FedEx was plagued with class action lawsuits of this type with a $227 million settlement in 2017 and a $226 million settlement in 2015, in the U.S. alone.
4. Contractors Own their Intellectual Property (IP)
In general, independent contractors own the copyright for their work, but employees do not. If you hire an independent photographer to produce photographs for your website, the photographer can later sell a license to someone else to use those same photographs. Even if you add language to your contract that says the product is work made for hire, it may not be valid. With an independent contractor, a work for hire arrangement is valid only when it meets these three conditions:
- The work must be commissioned or specially ordered
- Both parties must sign an agreement stating that it is a work made for hire prior to beginning the project
- The work must fall into one of these categories: a translation, contribution to an audiovisual work, contribution to a collective work like a magazine, an atlas, a compilation, an instructional text, a test, an answer key for a test, or supplementary work like a forward or an illustration
5. 1099 vs W-2 Employee
A primary difference between an independent contractor and a full-time employee revolves around how their taxes are filed with the IRS. A contractor will use a 1099, while a full-time employee uses the W-2 form. With the W-2, full-time employees have their taxes automatically deducted from their paycheck on a monthly basis. With a 1099, contractors must process their own payroll and submit their taxes to the government on a quarterly basis.
Hire Contractors Compliantly with an Employer of Record
A global expansion partner like Velocity Global can help mitigate risks associated with using independent contractors. Using our Contractor Classification and Contractor Management solutions, you ensure your contractor engagements are compliant with local labor laws. With compliant solutions, your business avoids legal fees, fines, and business interruptions that commonly come with contractor misclassification.
Our team of experts can guide you through the complexities of hiring a 1099 employee or contractor. Contact us today to learn more.