Before You 1099, Make Sure You W-9

Who Is an Independent Contractor?

When we’re talking about 1099s and W-9s, most people know we’re talking about independent contractors, but many people might not know that not everyone you hire can be considered an independent contractor. There are certain rules that dictate who qualifies as one and who doesn’t.

The biggest factor in whether a worker can be considered an independent contractor is control. Independent contractors control their own work. You may give them the project specifications and a deadline, but your contractor is entirely responsible for determining how that work gets done and how that deadline is met. Contrast that with employees, whose work you control. You tell them what to do, how to do it, and when to do it. As compared to independent contractors, employees have very little flexibility when it comes to completing projects.

While employee and independent contractor relationships can take many forms, there are certain factors that make one classification more likely than the other. For example, if your worker is regularly paid by the week or month, completes tasks full-time and on-premise, receives regular training and supervision, is an essential part of your business operations or can be fired at any time (or any combination of the foregoing), he or she is likely an employee. Independent contractors most often work on a temporary basis, are paid per project, use their own resources, frequently complete tasks off-site, set their own schedules and work for other clients at the same time.

When Might You Prefer an Independent Contractor?

Many people choose to hire independent contractors for discrete projects that require specific artistic or other specialized skills. Some of the most common examples of independent contractors are web developers, project managers, writers, marketing consultants, or graphic designers. When you have an isolated project that requires someone with these unique skill sets, it’s often logical to hire a freelancer to deliver the final product.

In many cases, it may not make a lot of sense to invest in hiring a permanent employee with these specialized skills, because you won’t put them to use very often outside of the present task. Opting instead to hire an expert freelancer or consultant on a project-by-project basis removes a lot of the administrative burdens that come with onboarding full employees.

Using contractors frees you from having to comply with minimum wage, overtime, or other salary regulations, because only employees are subject to employment laws. You also won’t be responsible for withholding taxes, paying for workers’ compensation or unemployment insurance, or providing benefits.

The independent contractor relationship exists solely for the duration of the project for which the contractor was hired. While you may choose to bring the contractor on for additional projects in the future, you’re under no obligation to do so, and there’s no awkward termination or layoff at the end of the project.

As you’re probably starting to see, hiring independent contractors rather than employees can be extremely convenient and cost-effective – so much so that you may be wondering why you wouldn’t classify everyone as an independent contractor. The answer is because, much like everything in business, there are rules and laws that prevent it and consequences for wrongly classifying your workers (more on that last part in a bit). Different government agencies have different rules about how and when you can treat someone working for you as an independent contractor. That’s why it’s crucial that you understand your employment relationships from the moment they start.

W-9s and Employment Agreements: Starting Your Independent Contractor Relationship Off Right

If you’re dealing with someone as an independent contractor, the first thing you should do is send that person a W-9 (you can get them from the IRS here). The W-9 is where your contractor gives you all of his or her vital information, like name, address, and Social Security number or Employer Identification Number. You can’t complete your 1099s without their W-9s.

When you get the completed W-9s back, file them away somewhere safe. After all, they contain sensitive personal information that needs to be kept secure. Then make a list of all your independent contractors, verifying that you’ve received W-9s from all of them. If any are missing, get them now.

Getting signed W-9s isn’t quite the end of the story. You and your new hires may be in accord that they should be classified as independent contractors, but you need to have an actual legal agreement to that effect. A signed independent contractor agreement is the lifeblood of every independent contractor relationship.

While the exact terms of any agreement will vary depending on the specific arrangement or project, there are many things that should be included in any independent contractor agreement including:

• The specific scope of the project and any required deliverables
• The payment terms, including amount and timing
• That the contractor will complete the work using his or her own resources, equipment, or supplies
• That the contract will cover all related expenses, unless otherwise agreed
• The end date of the relationship or the termination date of the project
• A non-exclusivity clause, making clear that the contractor may pursue and engage with other clients
• A liability clause, making clear that the contractor is responsible for his or her own liability insurance and that the employer retains no liability

The purpose of your independent contractor agreement is to leave no question about the nature of the employment arrangement or the intents of the parties in entering into the relationship. While a contract may not be enough to prove an independent contractor arrangement if the nature of the actual relationship suggests otherwise, it can go a long way toward showing your intent if the IRS or other agencies question the employment status down the line.

What Happens If You Get it Wrong?

Employment relationships can be complicated, and you’re probably wondering why the classification of your employees matters so much. Who really cares?

The answer is a long list of state and federal agencies. While independent contractor arrangements are unquestionably legal, many agencies would prefer it if all your workers were employees, so they institute lengthy regulations that pin your tax and other obligations to how you classify your employees. Among the agencies who care are:

• Tax-collection agencies – The most notable are the IRS and the state departments of revenue. These agencies want to ensure that they are collecting all the tax revenues you could possibly owe them, and your obligations to withhold and submit Social Security, Medicare and other employee taxes depend on the proper classification of your workers.
• Employee protection agencies – Several agencies exist to protect employee rights, and whether or not your workers are entitled to such rights depends on whether they are properly classified as employees or independent contractors. Some of the biggest protection agencies include the Department of Labor (regulates worker payment), the National Labor Relations Board (oversees union rights), the Equal Employment Opportunity Commission (protects against discrimination), and the Workers’ Compensation Board (oversees workplace injuries).
• Insurance agencies – Agencies like the Department of Labor and the Workers’ Compensation Board require you to pay into insurance funds to cover the possibility that employees will get laid off or injured on the job. Again, your workers are only covered as employees, making employee vs. independent contractor classifications crucial.

It’s important to remember that the burden of proof always lies with you, as the employer, when it comes to dealing with these agencies. If questions come up, it’s your obligation to prove that your workers are in fact independent contractors rather than employees.

So, what happens if you can’t meet that burden? Or if you improperly classified your workers from the start? Unfortunately, the penalties can be pretty severe. If it’s found that the people you classified as independent contractors should have been classified as employees, you may be required to pay back wages or retroactive insurance premiums. You could also have to pay several years’ worth of federal and state back taxes. On top of all that, there could be additional penalties. Depending on how much your company is worth, these amounts could be enough to sink your business.

Take the Right Steps from Day One

The good news? Your chances of facing agency action and having to pay taxes, fines or penalties are greatly reduced if you take the time to get everything in order from the start. The mere seconds it takes to download your W-9s and file your 1099s can save you a world of hardship down the road.

 

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Renee Poirier is product manager for Eagle View Filing Solutions, a division of Tenenz, Inc. based in Minneapolis. Visit www.eagleviewfiling.com for more information about online filing 1099s and W-2s.