Jul 23, 2021

Five 1099 Contractor Classification Myths

The last thing your business needs is an IRS audit - don't get caught uninformed!

You’ve worked hard to grow your business – long days, over-extended finances, time away from family.  Now, it’s finally paying off and the time has come to expand and hire more help! The rules of engagement are confusing out there, however; should you hire W-2 employees or those paid contractually and tracked via 1099?

Shifting regulations and gray areas present thin ice on which you must tread carefully while making these hiring decisions. The last thing your business needs is additional risk, so here are five common employee classification myths to avoid.

Myth #1: You can pay up to ten 1099 contractors before the IRS will audit your company for misclassification

There is no arbitrary number of independent workers that will trigger an audit. It could take only a single misclassified employee to capture the attention of watchdogs. Actions such as a 1099 worker applying for unemployment benefits, or questioning their status, can catch the eye of regulators who are hungry for what is perceived as missed payroll taxes, under-paid employee benefits, and potentially lost income taxes. Beginning in 2010, the federal government stepped up efforts to identify misclassified workers with an announcement to conduct 6000 random audits to identify misclassified workers. These activities were accelerated one year later with budget increases, and they continue today.

Myth #2: If my accountant doesn’t identify a problem, then there is no problem

No matter their prowess in other areas, accountants are not always trained on worker classification with the ability to fully assess and categorize a worker. Their focus is, of course, accounting and financial reporting. They may advise, for instance, that regular employees who work at home, a number that has grown by 5.6% recently, could be incorrectly categorized as Independent Contractors. If they are misclassified in the eyes of federal and state governments, you will still be held responsible for fines, penalties, and interest, in many cases these fees are retroactive.

Myth #3: If a worker clocks less than 40 hours a week, they can automatically be paid as an independent contractor

Classification checklists issued by the Internal Revenue Service and the Department of Labor do not allude to the number of hours worked as a checkpoint on worker classification. Problems with misclassification begin to pile up with this false belief, since both federal and state mandates can accrue for W-2 workers even with less than 40 hours a week. For example, states such as Connecticut, California or Massachusetts require sick pay accrual for days worked. If your workers are misclassified today, you could be held responsible for allocating retro benefits tomorrow.

Myth #4: Anyone working from home can be classified as an Independent Contractor

Among the biggest fallacies on this list is the belief that all remote workers can be readily classified as Independent Contractors. In 2016, GlobalWorkplaceAnalytics.com reported that fully 50% of the US workforce holds a job with at least partial telework, and 1 of every 5 workers teleworks with some frequency. Fortune 1000 companies are actually revamping their physical plant and work spaces to accommodate these changes, which has no bearing at all on worker classification. 3.7 million W-2 workers now work from home at least half of the time, so it is important to understand that the location in which a worker performs their tasks has no bearing on their classification.

Myth #5: Small businesses should not feel at risk for audits

All companies are at risk of being audited. In addition, the impact of an audit on a small business is much greater than a large company with the resources to handle requests for additional information as the IRS or local agencies dig deeper to properly classify. Even an insignificant line of questions can demand immense resources and time from a small business that has been “targeted” by the IRS. Even worse, some entities conclude that small businesses are, in fact, more likely to be audited by the IRS than larger corporations. According to an article in Small Business Trends, an algorithm applied by the IRS surmises that small businesses have a lower propensity to pay their “fair share” of taxes than larger ones, making them even more susceptible to an audit.