What is a 1099 employee?

A 1099 employee is another term for an independent contractor. The name stems from the form employers submit to the U.S. Internal Revenue Service (IRS) to report an individual’s earnings. Sole proprietors, consultants, freelancers, self-employed individuals, and gig workers (such as those who work for Uber, InstaCart, and DoorDash) are considered 1099 employees. 

W-2 employees vs. 1099 contractors

The primary difference between a 1099 contract employee and a full-time or regular employee is that a 1099 employee works for themselves, not your organization. This means they can set their schedule and have the right to decline work. They also supply their own workspace and tools, pay their own taxes, and secure their own benefits. 

In contrast, a regular or W-2 employee works a schedule set by their employer and completes assignments as directed by their role or supervisor. The employer provides the necessary tools to complete their work and withholds taxes, as well as Social Security and Medicare contributions, from their paychecks. Employees can access benefits like health insurance and paid time off.

How to classify a 1099 employee

To classify a contractor as a 1099 vs. a W-2 employee, they must meet specific qualifications. Organizations that misclassify employees, either inadvertently or deliberately to avoid paying taxes or providing benefits, risk significant penalties. Misclassified employees can sue for back pay and benefits, and companies can face tax penalties and other legal consequences. 

To ensure that someone is eligible to be classified as a 1099 contract employee, you can use a three-pronged test established by the Fair Labor Standards Act (FLSA).

Behavioral test

If you control a contractor’s work and how they do it, they are most likely an employee. For example, a contractor can decline a project, while an employee usually can’t. Although a company can set a deadline for a contractor, it can’t control where, when, or how the contractor works to meet that deadline. 

Financial test

Contractors control how they are paid, pay their expenses, and provide the tools and equipment to perform the work.

One good financial test is to evaluate the worker’s potential for profit or loss. Employees get paid on a regular schedule, receiving their predetermined pay rate. A contractor should be paid per project or on a commission basis, which creates the potential for profit or loss. 

Type of relationship

Most 1099 employees work on specific tasks or on a contract basis with a strictly defined scope of duties and contract start and end dates. If someone is hired permanently or completes work on an ongoing basis without a new or revised contract, they are most likely a W-2 employee. 

When to hire a 1099 employee vs. a W-2 employee

If you have a short-term project or require assistance from a professional with skills you don’t have in-house, a 1099 employee may be the best solution. However, if you want someone to provide a core function for your company, you need a W-2 employee vs. a 1099.  

To determine whether to hire a 1099 employee or a W-2 employee, ask yourself these questions:

• How many hours do you need them for? If you need someone to work more than 30 hours per week, a W-2 employee may be the best option. 
• How long do you need them for? 1099 employees are best for short-term projects. Consider a full-time employee for ongoing work.
• How much can you afford? Even without taxes for 1099 employees, the cost to pay by project or hour may exceed your budget. 
• Do they need to work in the office? If the project requires significant collaboration, or you prefer your team to work on-site, a W-2 employee is a better option. 
• How will you pay them? If you plan to pay a 1099 employee a salary or via payroll with other employees, you may need to classify them as a W-2 employee. 

The pros and cons of 1099 employees 

If you are trying to decide whether to hire independent contractors, consider the advantages and disadvantages of doing so. 

Pros: 

• Less expensive: Hiring a contractor to complete specific projects can cost less than hiring a full-time employee. You don’t have to pay for insurance, retirement plans, or other benefits—including paid time off—or manage training and onboarding.
• More flexible: You can hire 1099 employees as necessary, making them an option for less predictable businesses or specific projects that in-house talent can’t manage. Working on a contract basis also makes it easier to end relationships when needed. 
• Access to more talent: Freelancers and consultants can fill gaps in your roster, providing skills and talents that your team might not have.
• Less regulation: Independent contractors are not subject to the same federal employment regulations as employees, so they can be easier to manage. You don’t have to worry about 1099 employee taxes, overtime rules, unemployment contributions, workers’ compensation, or other regulations that govern W-2 employees. For example, freelancers make their own hours, so there are no restrictions on how many hours a 1099 employee can work.

Cons:

• Risk of misclassification: There’s a significant risk of misclassifying a worker if you aren’t clear on what qualifies as a 1099 worker. Misclassifying 1099 employees can result in tax and legal consequences. 
• Increased expenses: Although independent contractors or freelancers can cost less, over-reliance on them can increase costs because they may charge higher hourly rates than employees. 
• Reduced control: If you have specific work processes and procedures, or you care about how work is completed, you’ll have more control over a W-2 employee than a 1099 contractor. 

Rights of 1099 employees 

Despite their status as independent contractors, 1099 employees have certain rights and protections:

• They have total control over their working hours. 
• They can work where they want.
• They have control over subcontracting techniques and practices, unless contractually prohibited. 
• They have control over work processes.
• They have property rights to the work they create unless otherwise stated in the contract. 
• They have the right to a written contract stipulating the nature of the work, the pay rate, payment timelines, project details, and conditions for termination. 
• They have the right to a written termination procedure, which includes payment for early contract termination.
• They can advertise and promote their services and take on additional projects.
• They can take legal action for contract violations. 

Get help classifying and managing 1099 employees 

Get help classifying your contractors from Oyster, and avoid serious legal and tax consequences. We can help you assess your risks, evaluate contracts and employment agreements, and convert contractors to full-time employees when necessary with our simple, intuitive platform.

Disclaimer: This article and all information in it is provided for general informational purposes only. It does not, and is not intended to, constitute legal or tax advice. You should consult with a qualified legal or tax professional for advice regarding any legal or tax matter and prior to acting (or refraining from acting) on the basis of any information provided on this website.