I’m seeing a growing trend where employers are electing to hire new employees as a 1099 contractor, rather than a more traditional W-2 employee. The two biggest benefits for the employer are lower payroll costs, and more flexibility. Since there isn’t always a defined amount of work offered to the new hire (e.g. part time, full time), the employer looks upon that new person as a flexible resource, rather than a more rigid obligation. The biggest downside to the worker is that they generally don’t get any benefits. If an employee is classified as a 1099 subcontractor, the employer doesn’t have to pay state or federal unemployment, workers compensation insurance, or federal taxes.
The concern I have is over the proper definition and ultimate taxation of those wages. The Labor Department is now signing agreements with almost 12 states to share information about improperly labeled workers, in order to crack down on businesses that cheat workers. This shared information between the state and feds will expose the business to multiple fines.
I’ve sat in on a few IRS audits regarding employment tax evasion and I can assure you that there is no wiggle room here, with interest and penalties on back taxes going as high as 25% per year.
By definition, a 1099 subcontractor must meet the following criteria: they cannot work all of their available hours for one employer, which means they need to have other contracted engagements. They need to carry their own insurance. A W-9 form must be on file with the employer. And preferably, a business card should be attached to that W-9 form. The idea is that this contracted employee should look and feel like they are holding themselves out as an independent worker. Go here for the most recent IRS publication: http://www.irs.gov/businesses/small/article/0,,id=99921,00.html