7 Mistakes That Lead To 1099 Worker Misclassification Liability

By using 1099 contractors, your company can take advantage of many tax benefits. Unfortunately, the use of contractors has been somewhat reduced over the past few years due to the increased risk of worker misclassification liability. Misclassification of independent contractors, who the government views as employees, can result in substantial liability and penalties for back taxes, overtime pay, workers compensation, employee health benefits, retirement benefits and more.

The government is increasingly cracking down on misclassification. For example, the Department of Labor forced offending employers to pay $6.5 million in back wages in fiscal 2010, up from $2.6 million in 2009.

According to Gary Gansle, an employment lawyer for Dorsey & Whitney, “The Department of Labor has requested a specific $25 million line item in its 2011 budget to hire additional investigators and enforcement personnel, as well as to create competitive grants to encourage state agencies to focus more attention on this issue.”

If you are going to use 1099 contractors, it is essential that you aware of how this is done and common mistakes that have gotten other organizations into trouble.

Seven Common 1099 Contractor Mistakes

1. Do you offer in-depth instructions or extensive training? Do you require that the worker comes on-site from time to time for training or meetings? If so, this may be classified as an employer – employee relationship. Simply put, when you exercise this type of control over a worker they often cannot be classified as a 1099 contractor.
2. Follow the money. The financial relationship is something the IRS looks at when determining if worker misclassification took place. A contractor must use all his own equipment. If a worker is supplied with office supplies, cell phone use, a company vehicle or other tools, free of cost, an employee relationship may have been established. A legitimate 1099 contractor will provide his own equipment and tools without receiving reimbursement for them from the company for which he is working.

Other indications that your contractor may be classified by the government as an employee include workers who:

1. spend most of their time solely performing work for your organization;
2. are subject to frequent oversight and instruction from one or more employees who “manages” him;
3. must adhere to an organization-mandated schedule and/or work on the organization’s premises;
4. contribute to the company’s core business functions; and/or
5. have an ongoing relationship with a company (vs. hired for a specific project and then dismissed).

If your company would like to receive the benefits of using highly skilled workers and possibly reduce 1099 misclassification liability, there are other staffing arrangements which can be utilized through a staffing agency. All this said, there is a lot of gray area when attempting to determine whether a worker is an employee or 1099 contractor. If you are unsure of how a working relationship should be classified, you can ask for the advice of a qualified tax professional, or you can complete the IRS Form SS-8 and get the federal government’s determination.