Employees Versus 1099 Workers

A discussion around the rules governing when a worker is considered an employee for tax, insurance, and legal purposes. June 15, 2009

I work for a woodshop that currently has around ten employees. Most employees are on the books but about four are 1099. What are the benefits of each to the employer or employee?

Forum Responses
(Business and Management Forum)
From contributor S:
It's really not about benefits of being an employee or 1099. The IRS has rules that determine whether you are an employee or an independent contractor. If you are an employee, the employer pays all employment taxes, workers comp, etc. If you are an independent contractor, you normally get paid more, but you normally need to be licensed/insured, you need to pay for your own workers comp (if you want it) and you pay the full amount of the self employment tax. Also filing your taxes become a little more complicated. So the real benefit goes to the employer when he/she pays on 1099, which is why many do it illegally. In a cabinet shop most positions wouldn't qualify for independent status. Usually installer is the only one.

From contributor J:
1099 isnít off the books it just means at the end of the year you have to pay all applicable taxes on any money earned. Basically those four employees are sub- contractors and they should have to have their own workers comp and liability insurance which benefits your employer, but it probably benefits those four workers too as long as they have enough write offs, etc. they might not have to pay any taxes. I have been in business for three years and have not paid anything in taxes and I usually get a small refund every year. I have a small shop and do all types of carpentry and half of my work is through contractors who give me a 1099 at the end of the year.

If you plan on starting your own business some day it would benefit you to get your own liability insurance and workerís comp. Not only can you ask your employer for more money, you can then start doing work on your own - homeowners or contractors. But I would check with your employer he might take it as you are going to quit. I donít know how long you have been with this company or well you know your boss. A boss can be funny about this stuff sometimes.

From contributor J:
There's no benefit to an employer who should be collecting taxes on employees and isn't. If he gets caught the IRS, the state tax commission and the state employment security agency (unemployment guys) will all want their pound of flesh, with interest and penalties. I've seen shops fly under the radar for years and never get caught. I've also seen a shop get jammed-up on this and it's awful. If my family doesn't eat, the quarterly employment tax filing and monthly sales tax payment (which is whole different conversation/can of worms) will still go in.

From contributor S:
In counseling for SCORE I find this question comes up over and over from new business owners - who see it as a way to save a little money. Some industries (roofing, acting) frequently use 1099ís as a way of avoiding the headaches of collecting withholding and avoiding FICA contributions - particularly with crews of semi-independent or fast turnover laborers. Moreover, it is sometimes a way of trying to avoid both unemployment taxes and Workman's Comp Insurance bills.

In my opinion, this is almost always a mistake. Problems arise most frequently when you pay a person as an independent contractor for a period of time, business slows, and the contractor realizes that they can't collect unemployment. More rarely, but much more seriously, it arises when a contractor is injured, get's fixed at the hospital, and then the hospital goes looking for the responsible party. Both Workman's Comp and Unemployment Insurance are cheap for what you get in return. The second keeps guard for spurious claims, and covers what needs to be insured; the first eases the pain of the sad, but necessary business of laying people off when business slows.

Our company regards a plumber who comes to fix the toilet as an independent contractor. Otherwise, if you work here, you're an employee. We're going to deduct taxes and we're going to include you in our insurance audit. If you come here as an independent contractor (to fix the roof) better be prepared to show me your workman's comp policy - otherwise, it's a no-go.

From contributor Z:
If the 1099ír does more than a certain percentage of his work for the same company then he is an employee of that company. If he uses the employers tools, and is at any time under direct supervision of the employer then he is an employee. Itís complicated and the rules are subject to interpretation - usually the governmentís.

From contributor T:
When I hired my first helper a couple years ago, he wanted to remain an independent contractor, taking a couple weeks off a few times a year to do side work, take long vacations, etc. I was fine with that and filed 1099's for him. It was a mutually agreed-upon deal, but still risky for me because technically the taxman could argue he was an employee (he worked under my direction, in my shop, with my tools, most of the time).

On the other hand, he invoiced me for all payments, could take off when he wanted, frequently worked outside of the shop with his own tools, and had his own liability insurance as a sole-proprietor carpenter, so on these counts we met the IRS requirements for independent contractor and 1099 status. I guess it would be accurate to say that most of the time he was technically an employee, but some of the time he was independent. If he was seriously injured in my shop, however, any lawyer could probably take me to the cleaners by arguing the one side of the picture (he was more an employee than not and I should have had a workerís comp policy for him). These issues are not to be taken lightly; I myself know personally how devastating a hand injury can be, and this guy has little kids! But as I said, it was his preference, and I went with it. It's history now, as I lost him when business slowed early this year.

A couple points of clarification about insurances (and I welcome others who are more sure about this to contribute). Sole proprietorship is a form of business ownership/operation. As a sole proprietor, I can have no employees or fifty. Other business formats include corporation, s-corporation, and LLC (limited liability corporation). Each has different taxation and liability pros and cons, among other things. Some posts have suggested that any independent contractor (someone being issued a 1099 as in the original post) should have workers comp insurance (which is medical and disability coverage in the event of injury on the job) and pay into his state's unemployment compensation fund. But a sole proprietor (as best I understand it) is not eligible for either worker's comp insurance (also typically issued by the state) or allowed to contribute to the stateís unemployment compensation fund (maybe it varies by state).

Instead, a sole proprietor relies on personal medical insurance in event of injury, and when work runs dry, well, his income dries up too. By converting a sole proprietorship to one of the other three business forms of incorporation, all this changes because the "owner" technically becomes an "employee" of the business entity, and can receive some of the same benefits of an employee. Structuring a business as a corporation is a legal process requiring a lawyer and costs a little money. The four guys in the original post, and the thousands of others like them, are almost all self-employed sole proprietors. If you're operating a full-fledged business as I am, you surely need to have a business liability policy. If you reach the point of needing to hire someone, you're safest bet is by the book - proper tax withholding, unemployment comp, and workers comp as required by law. But those last two won't be part of your safety net as a sole proprietor, as many of us are painfully aware lately.

From contributor W:
Usually what brings this situation to everyoneís attention is one of the 1099 employees has an accident and now instead of dealing one on one with the 1099 contractor you are dealing with his family and they want compensation. Employers who get involved in this scheme are liars and thieves and personally I would not want to work with that company and obviously you are starting to feel the same way.