Many businesses have looked at the cost of hiring an employee versus a freelance worker and have decided to classify them as a 1099 worker to save money. Unless the worker actually qualifies under IRS and state guidelines, I don’t recommend you do this.
The IRS began auditing businesses looking for misclassifications, and the penalties and interest you’ll have to pay will be much higher than any cost savings you will gain by classifying the worker as an outside contractor.
The guidelines the IRS uses when determining if a worker is an employee or contractor fall into three categories: behavioral control, financial control, and relationship of the parties. Let’s look at these in more detail.Behavioral Control refers to facts that show whether there is a right to direct or control how the worker does the work. The business does not have to actually direct or control the way the work is done – as long as the employer has the right to direct and control the work. If you say when, where and/or how the work is to be done, the worker is most likely an employee.
Financial Control refers to facts that show whether or not the business has the right to control the economic aspects of the worker’s job. These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc. If the worker is guaranteed a regular wage for a particular period of time, this generally indicates they are an employee.
Type of Relationship refers to facts that show how the worker and business perceive their relationship to each other. Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business? These generally show the worker is an employee and not a contractor.
It’s important to properly classify the worker to avoid fines for failing to employ them and pay the accompanying payroll taxes. Your state may have more stringent guidelines than the IRS, so verify rules with your state employment agency to be in compliance.