The controversy over worker classification as either employee or independent contractor has been brewing for many years. There are definite advantages and downsides for each side, and some employers have gone as far as asking new hires the option of a W-2 or a 1099-MISC.
Employers’ Dilemma: W2 Employee or 1099-MISC?
Employers report employee wages, tips, bonuses and all qualifying compensation using IRS Form W-2. By filing a W-2, the company becomes responsible for collecting and filing withholding and Social Security taxes. On the other hand, compensation for independent contractors is reported by payers to the Internal Revenue Service using Form 1099-MISC.
Employees typically receive other benefits while independent contractors, who are technically self-employed, are excluded from non-payroll benefits such as health, life and disability insurance, an IRA match and other perks. In some instances, the lines between employee and independent contractor have blurred so much that employee classifications becomes complicated.
Defining the Employer-Employee Relationship
The IRS has very specific guidelines for classifying workers into employees or contractors. In general, the extent of employer or payer control over the worker’s time, work methods and output determines if that person’s compensation should be reported on a Form W-2 or 1099-MISC.
The worker is a W2 employee under the following conditions:
- Work hours are set by the company and usually consist of a fixed schedule.
- Work process is defined by the company and training is provided to workers by the company.
- Workload is assigned by a supervisor and workers are required to meet set criteria for performance.
- Equipment, tools and supplies required to perform the tasks are provided by the company.
- Workers have a single employer.
The worker is an independent contractor under 1099-MISC definitions if the following conditions describe the work relationship with the client or payer:
- Work schedule is determined by the worker.
- Assignments are accepted on a case-by-case basis and worker can reject or opt out of assignments.
- Workers complete assignments using their own methods and work process.
- Tools, equipment and supplies are provided by the worker although the company may provide some training.
- Workers may provide their services to other clients.
Understanding Worker Benefits
When employers report compensation on a W-2, it means withholding Social Security and income taxes. However, employers also match the employees’ share of the taxes. For 2015, the combined tax rate for Social Security and Medicare is 7.65 percent. Self-employed workers receiving a 1099-MISC at the end of the calendar year will have to pay the same taxes at 15.30 percent tax rate.
Independent contractors receive more compensation upfront because withholding taxes are not applied. However, independent contractors may be required to make quarterly estimated payments of withholding taxes or risk facing penalties when they file their taxes.
Importance of the Right Employee Classification
The Internal Revenue Service takes a dim view of employers who try to skirt labor laws by designating workers as independent contractors when they should rightfully be considered full or part-time employees. Employers are held responsible for transgressions with stiff penalties imposed for misclassification. A California judge recently announced an $11 million verdict against the San Diego Union Tribune for misclassifying paper carriers as 1099 employees.
Payroll is one of the biggest expenses of most companies, so a hiring strategy involving both employees and independent contractors may lead to significant savings that would impact the bottom line. The key is to work with professional payroll companies that offer comprehensive programs to address the complex details of your payroll. In Brookfield and surrounding areas, Integrated Payroll Services will provide solutions to your payroll needs from daily time records, payroll preparation and disbursement of wages. This will give you the time to devote to your core business.