Understand W-2's and 1099s Gig Economy

Similar to exempt and non-exempt classifications, workers are classified in one of two ways for tax purposes:

• W-2 employee
• 1099 contractor

As an employer, you need to know the difference between the two.

Before we go any further, here's an important passage shared by the IRS:

"You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed."

This one passage can help you better understand whether to classify a worker as an employee or a contractor.

Points of Consideration

When classifying workers, it's important to take the following three points into consideration:

1. Behavioral Control

Does your business have the right to control how the work is done and what type of work is completed, such as through direct instructions or training?

If you train the worker, direct what they do, and specify how the work is completed, he or she is probably an employee.

Conversely, if the person takes full control of the project and sets their own hours, he or she is likely an independent contractor.

2. Financial Control

While not always the case, employees are usually paid salary or an hourly wage.

Independent contractors typically receive a flat fee per project, although there are times when other arrangements - such as a monthly retainer - come into play.

3. Type of Relationship

When examining the type of relationship, the IRS suggests that you review the following:

• Written contracts that outline the relationship and scope of work to be performed
• Whether the company provides the worker with employee-type benefits, such as vacation time, medical insurance, and access to a retirement account
• The permanency of the arrangement
• Whether the services performed by the worker are a critical aspect of the regular operation of the business

For example, if there is a contract in place, you are not giving the person benefits and the arrangement is short term, you are likely talking about a contractor. If the person is receiving benefits, there is an understanding this is a permanent role, and they help the regular operation of the business, this person is likely an employee.

Bottom Line

With the gig economy picking up steam, a growing number of people are working as independent contractors. Just the same, companies are coming to realize the benefits of hiring contractors, as opposed to employees.

As a company owner or HR professional, it's imperative to understand how to accurately classify workers. With the IRS watching closely, there is no room for error.

If you are considering using contractors, you may want to consult with your accountant to ensure you are classifying roles correctly.