An independent contractor is a business or person who performs services for another party or individual when a contract exists between them. The contract spells out what duties are expected, how much will be paid for the services performed, how much work is expected, and when it is scheduled to be completed, and other work expectations.
There are many differences between an independent contractor and an employee who works for the same employer every day.
An independent contractor pays their own social security, is not entitled to workers’ compensation benefits, pays their own income taxes, and has no retirement or health plans. The IRS (Internal Revenue Service) looks especially close at agreements between the independent contractor and whom they hire their services out to when it seems like the contractor is too much like an employee.
As an independent contractor, you must be able to decide where and when you will work, what work you will perform, do the work for others, have your own equipment, and other factors that make you different than an employee. Being an independent contractor means you have true independence in your work.
An employee is one who is hired for a salary, wage, fee, or another form of payment to work for a specific employer. Agency law defines your employer as the principal and an employee as an agent. It is essential to know who is an employee when injured to know whether or not you are entitled to workers’ compensation benefits. It is also necessary to know who is an employee should damage occur to another entity so liability can be placed on the employer.
The 1099 Form
The 1099 form is a document used by the IRS (Internal Revenue Service) to keep track of income received by sources other than employment. The IRS calls a 1099 an information form. This form tracks income received by someone, from another person, or business that they are not formally employed by. The 1099 form shows all income earned for an entire year. People receive this form for different reasons, according to the various types of income they make.
The W-2 is one form used for reporting income, and the 1099 form is an option that is connected to your tax return. It will serve as proof that income was paid to you as a taxpayer. The 1099 form includes a person’s social security number so the IRS will be able to track the information on this form to determine if you have reported the income to them on your income taxes.
If you receive a 1099 form, it does not mean that you owe taxes on the income reported on the form. Everyones tax return is different as they depend on your individual circumstances. The components that decide the amount of tax you must pay are based on :
- Your assets
- The type of 1099 you have received
- The deductions you are allowed to claim
The 1099 Form and Its Reporting Requirements
If it has been established that an employer is paying an independent contractor, the contractor has to complete a Form W-9. This form will request the contractor’s correct name, along with their Taxpayer Identification Number (TIN). The Taxpayer Identification Number can be either an SSN (social security number) or EIN (employer identification number). The employer should keep the W-9 in their files for four years in case any questions arise from the worker. The 1099-Misc is the most common form used by employers or payers to report monies earned by independent contractors.
A 1099-MISC is a Miscellaneous Income tax form and is a type of 1099 form that is used when others do not apply. Independent contractors and freelance workers receive this form after receiving at least $600 in payment. Other forms require $10 as a reporting minimum for things such as awards, royalties, and prizes.
A 1099-Misc is used when a payer pays money to someone not classified as an employee, such as a subcontractor, accountant, attorney, or independent contractor. The party receiving the money will have to have received more than $600 for services provided during the year. The 1099-Misc must be given to the independent contractor by January 31st of the following year after payments made. Since 2016, it is also necessary to provide the IRS with a copy of this form.
Independent contractors sometimes have their own employees, or they might hire another independent contractor (subcontractor). If this is the case, the contractor is also responsible for filing and reporting any monies paid to these parties.
Income Received by an Independent Contractor
Independent contractors do not receive a W-2 from the companies or clients they work for independently because they are not considered an employee. An independent contractor is given a 1099 form; usually, a 1099-MISC, if your income received, is more than $600 within a reporting tax year.
The government requires businesses to send their independent contractors 1099-MISC by January 31st with the amount of income paid to them over the past year. Some of those who receive 1099s include freelance writers, Lyft or Uber drivers, Artists, or those working on a contract basis.
If as an independent contractor, if you have made less then $600, you are not required to receive a 1099 form. If you owe taxes, as an independent contractor, you will have to pay them all in full as there have not been any withheld from your pay. If you end up owing more then $1,000, you can make payments in quarterly tax payments. The form 1040-ES is used to make payments quarterly by estimating your tax liability on your most recent quarter.
What are Misclassified, 1099 Independent Contractors?
The IRS (Internal Revenue Service) believes there are employers misclassifying millions of workers across the country as independent contractors. Some have done this in error, while others do it intentionally to reduce labor costs and to avoid paying federal and state taxes.
This misclassification between employees and independent contractors is complex and also a serious matter. When an employee is misclassified, they lose workplace protection, do not receive overtime pay, cannot join a union, look at an increased tax burden, and in most cases are not eligible for unemployment insurance or disability compensation. When an employer misclassifies whon they should have considered as employees, the government also loses. Local, state, and federal governments suffer revenue loss when employers bypass paying their tax obligations.
What Defines an Independent Contractor?
As an independent contractor, you provide a service or product to a business or another individual. This service or product is performed under the terms of a contract which will dictate your work outcome; however, as the contractor, you keep control as to how you will provide the goods or services. Independent contractors are not subject to an employer’s guidance or control except for any instructions outlined in the contract between the two. The independent contractor generally treats their employers like a client or customer, and usually have more than one at a time, and are considered self-employed.
A business or company might pay an independent contractor and their employees for similar or the same work. The legal difference between the two is that the employee has income taxes withheld from their pay along with Social Security, and Medicare, whereas the independent contractor, does not. The independent contractor is also not protected by labor or employment laws.
Many professionals find the line between a self-employed independent contractor and an employee blurry. There are factors to consider to make the distinction easier, and different standards used to figure out if an individual is legally an independent contractor. There are many intricate factors involved with the different contracts created and the specific workplace situations, but the DOL (Department of Labor), and the IRS do employ tests that provide useful guidelines to use in deciding who is not and who is an independent contractor.
- DOL Economic Test
The Department of Labor looks to ensure all employees are accurately classified because only as an employee are you entitled to receive FLSA (Fair Labor Standards Act) benefits along with the Federal minimum wage, overtime pay or other workplace benefits. Using what they have called an Economic Reality Test, the DOL determines who is an employee and thus eligible to receive the workplace benefits. The test is used to find out whether or not the person in question is economically dependent on the employer they are producing products or performing services for.
The DOL gets it's position from judicial example and stresses seven factors the court considers essential:
- How permanent is the relationship between the two parties (independent contractor and employer)
- How much control the employer (principal) has over the person and to what degree
- How much or the amount of foresight the claimed independent contractor has in open market competition and how much they insert initiative and judgment as required success in the operations of the business
- How do the services perform play into an integral part of the employer’s (principal’s) business
- How much has the independent contractor invested into the facility or its equipment
- Is there an opportunity for the independent contractor to share in losses and profits
- To what degree or how much influence does the independent contractor have in the operation or business organization
These seven factors make up the Economic Reality Test and are designed to help an employer decide between an independent contractor and employee status. Common sense should be the best test, but for those with doubts, these seven factors will help spell out the classification more easily. If an employee sells their services to only one employer, and only invests their time in one business, it is said they are economically dependent on that work. An independent contractor, on the other hand, is in business for themselves, invests in their own supplies and equipment, and works for a variety of clients or customers.
Other questions used in most states in an economic realities test are used to determine what degree the worker is economically dependent on the business. State workforce agencies may have state-specific information or questions to use in an individual state, but the following are what is asked generally :
- Regarding employment laws is the individual covered by state and federal labor and employment laws, if not, the individual is an independent contractor.
- During the hiring process did the individual complete an application that was then handled by the HR department. Once the application was reviewed, did the applicant receive an offer for the position and were they asked to give additional information such as date of birth, marital status, and citizenship status? If you did not follow this form of hiring, then the individual is an independent contractor.
- Were there tax documents filled out with the applicant's name, address, SSN, filing status and a number of exemptions? If not, then the individual can be classified as an independent contractor. In this case, the individual should have been asked to provide a W-9 with their Taxpayer Identification Number.
- Will you, as the business owner, be reporting the money paid to this individual on a W-2? If not and you are only reporting amounts over $600, then the individual is an independent contractor.
- Will you be reporting to state and federal Unemployment Insurance for this individual? If not, then this individual is an independent contractor.
- Will the pay period for this individual remain the same and be based on a weekly, biweekly, or monthly basis. If not and you have made arrangements to pay the individual upon receipt of an invoice, then this individual is an independent contractor.
- IRS Service Test
The Internal Revenue Service has an interest in identifying misclassified employees as it means there is lost tax revenue through this error. There is not one factor the IRS looks at to determine who is or who is not an employee versus an independent contractor. They look at a number of factors to determine the difference, including whether or not the employer controls the services performed by the worker. If the employer has control over the person in question and dictates their job responsibilities, then that person is considered an employee and not an independent contractor.
Evidence proving the degree of independence or control falls into three categories:
One aspect to look at is the business characteristics of the worker’s job, and determine if they are controlled by the payer (employer), for example, how they are paid, are expenses reimbursed, or who provides the supplies and tools? Employees cannot incur a loss or realize a profit from their work; these are only possible by an independent contractor.
Does the employer (principal) control or have the right to tell the worker how to do their job? One manner to check this control feature is to know if the worker was required to attend training provided by the company. If you are expected to attend training courses to perform a task, then you are expected to follow company rules and guidelines and therefore likely to be an employee.
- Form of Relationship
This factor looks at whether or not there are any written contracts or employee-type benefits offered to the worker, such as vacation time, pension plan, or insurance. They also look to see if the work provided by the person in question is a vital aspect of the company.
Businesses must use these three guidelines and weigh them when deciding if a person should be considered an independent contractor or an employee as the tax codes do not definitely define an employee.
Why Employers Misclassify an Independent Contractor
The number one reason an employer will misclassify an employee as an independent contractor is that it saves them from having to pay unemployment insurance or Social Security. Tax savings such as these are quite significant, and they also save from Medicare taxes and income taxes on an average of twenty to forty percent. There are other advantages beyond savings from taxes that influence an employer to misclassify a worker:
- The EEOC (Equal Employment Opportunity Commission) have laws that apply to employees in the workplace. Employers may misclassify their employees to avoid having to follow these laws. Laws enforced by the EEOC include discriminating against race, gender, disability, age, or color. An employer does not have to follow these rules when considering a worker as an independent contractor.
- Independent contractors are not eligible for employer-based healthcare. These workers are also not entitled to a pension plan and therefore save companies considerable expenses.
- As an independent contractor, an employer does not have to abide by legal responsibilities such as paying a minimum wage or following the laws of how many hours one works. They are not required to follow the rules regarding break times or rest times. They are released from these obligations because labor and employment laws are based on employee-employer relationships.
- Independent contractors are not allowed coverage by the National Labor Relations Act, so when an employer misclassifies workers, they can in effect thwart union organizations.
- Some employers misclassify employees so they do not have to verify U.S. citizenship, or that a work visa covers certain workers. When they do this misclassification, employers are able to ignore labor laws and exploit low wage immigrant workers without worry about legal repercussions.
It is not easy to determine the volume or extent of employer misclassification as this information is not voluntarily reported, and there is not a government agency in charge of conducting comprehensive searches to locate those misclassified. Misclassifications happen in nearly all major industries including janitorial, agricultural, trucking, home health care, childcare industries, and many others. One of the sectors with the most misclassified workers across the globe is the construction industry. A state audit, when performed, can only target approximately two percent of its employers as most of the misclassifications occur in the underground economy. It is believed the actual numbers are significantly underestimated.
California Laws and the Independent Contractor
California looks to the interpretations of enforcement agencies and the courts to determine if a particular situation classifies one as a worker (employee) or an independent contractor. When these matters reach the court level to establish one’s status, DLSE (Department of Labor Standards Enforcement) starts by assuming the worker is an employee.
This assumption is rebuttable, and the actual determination depends on a number of different factors. The facts will all be closely examined in regards to the service relationship, and the law will be applied to those facts. Generally, when matters come before the DLSE, they will apply the ‘multi-factor’ or ‘economic realities’ test adopted by the California Supreme Court in 1989, 48 Cal.3d.341. When the economic realities test is applied, the most significant factor that is considered is whether or not the employer had control or the right to control the worker. This control would apply to both what type of work was done and how it was expected to be completed.
Even if there exists an absence of control over work details, an employer-employee relationship can be found if the principal has pervasive control over the worker, the worker’s job or duties are an integral piece of the business’s operations, or the nature of the work makes precise control unneeded.
Other points considered by California law is whether the worker has a written agreement stating they are completing the work as an independent contractor, and whether or not they have been issued a W-2 form rather than a 1099 Misc form. One point to remember is that an employer cannot change the status of an employee to an independent contractor by requiring you to assume a burden that is imposed on the employer by law. This burden would be withholding payroll taxes and not reporting to the taxing authorities.
What Misclassification Can Cost You
Misclassification of employees costs workers the loss of their benefits and rights. This misclassification impacts the effectiveness of many state and federal programs and creates unfair competition among law-abiding employers. If you have been misclassified, it is your right to change this status and start receiving the benefits you deserve.
Find an Employment Attorney Near Me
If you are being misclassified as a 1099 Independent Contractor call our Los Angeles employment attorney at 424-781-8411, you are entitled to workers rights and benefits and Stop Unpaid Wages is ready to help you gain the benefits you deserve.