Enter to open, tab to navigate, enter to select
A Top Ten List for Using 1099-MISC Workers
Practical Law Legal Update 7-604-5485 (Approx. 6 pages)
A Top Ten List for Using 1099-MISC Workers
by Practical Law Labor & Employment
| Law stated as of 12 Mar 2015 • USA (National/Federal) |
Guidance for companies using independent contractors instead of employees. These resources discuss best practices for properly classifying independent contractors. This enables employers to avoid claims that the contractors were misclassified for IRS employment tax obligations, are owed Fair Labor Standards Act (FLSA) minimum wage and overtime pay, have state and federal employment law protections, or are entitled to employment benefits typically reserved for employees.
Using independent contractors can save companies money, increase their staffing flexibility and reduce their exposure to employment litigation. Employers do not have to pay employment taxes on behalf of independent contractors and are not required to pay them minimum wage or overtime pay under the Fair Labor Standards Act (FLSA).
Many state and federal employment laws, including Title VII of the Civil Rights Act and state workers' compensation statutes, specifically cover only employees. Those protections do not extend to independent contractors. In addition, companies can avoid the expense of employee benefits, including paid vacation, health insurance and participation in a pension plan, by using independent contractors instead of employees.
Misclassification of independent contractors, however, can result in significant penalties. A company may be liable for unpaid taxes, wages and overtime compensation, and the value of employee benefits. Compliance is complicated by the different independent contractor tests that apply in certain situations. For example, the IRS's test is different from the test applied to misclassification claims under the FLSA.
A number of best practices, however, apply to all independent contractor arrangements. For example, companies using independent contractors should:
- Ensure that the independent contractor controls the work. When drafting an independent contractor agreement, avoid using words like "control" to describe the company's role in the contractual relationship. Specifically state that the independent contractor controls the manner and means of the work and that the company is interested only in the result. Do not provide the independent contractor with training.
- Limit the company's supervision of the independent contractor. If possible:
- require only compliance with industry standards;
- do not require that the independent contractor personally provide services to the company (the independent contractor determines who will perform the work); and
- avoid requiring a specific location where the work must take place.
- Avoid treating the independent contractor like an hourly worker. Avoid requiring specific hours of work. Avoid payment by the hour, day or week. Pay by the project or task, if possible. Provide payment for services to the independent contractor's business entity, not directly to the individual worker.
- Avoid treating the independent contractor like an employee. Specifically state that the relationship is an independent contractor arrangement. Handle independent contractor performance issues as breach of contract issues, not as disciplinary issues. Pay for services out of the company's accounts payable, not its payroll. Do not make the independent contractor eligible for company benefits and require a waiver of any right to participate in those benefits. Do not include the independent contractor in employee meetings or activities.
- Require the independent contractor to provide the necessary tools and certifications. Place responsibility for taxes, insurance, business licenses and the like on the independent contractor. Require the independent contractor to provide all necessary tools, equipment and related items. Specify that the independent contractor determines its business format (for example, corporation or LLC). Independent contractors should generally be responsible for all of their business expenses.
- Define the length of the contractual relationship. Specify the length of the contractual relationship instead of leaving it open-ended, if possible. Avoid contract provisions that suggest an at-will employment relationship.
- Specify that the independent contractor can perform services for others. Avoid unreasonably limiting the independent contractor's work for other clients by requiring set working hours, for example. Some state laws, courts and agencies do not classify workers as independent contractors unless they regularly perform the same type of services for others.
- Avoid engaging an independent contractor for work that is integral to the company's business. Do not use an independent contractor to perform certain work if the company's success depends on that work.
- Avoid using independent contractors for the same work performed by company employees. Workers who perform similar work should be classified the same way. Consider conducting an internal audit to determine if inconsistencies exist.
- File Form 1099-MISC. File IRS Form 1099-MISC, as necessary, to report payments to independent contractors for services rendered.
The extent of a company's employment obligations is largely determined by correctly classifying workers as independent contractors or employees. Improper classification can mean significant liability.
Practical Law has published guidance on using independent contractors, including:
In addition, Practical Law offers a free 75-minute webinar on best practices for using independent contractors. Register here for the live webinar on Thursday, March 26, 2015, at 1:00pm ET.