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Nov 30, 2023

You’re Hired … The Myth of the 1099 Employee

Sponsored Content provided by Robert Burrus - Dean , Cameron School of Business - UNC-Wilmington

This piece was contributed by Joseph Betts, J.D., Business Law Instructor within CSB.
 
It’s probably the single most common headache that businesses large and small share.  Handling employee issues can be costly in not only dollars, but time as well.  It’s not surprising that some smaller businesses might choose to seek out a different route.  They might look for a way that would enable them to hire workers to staff the business, label the workers as "independent contractors" and NOT have to deal with the hassle of, among other things:
 

  • Federal and State Tax Withholding
  • Unemployment Insurance 
  • I-9 Verification
  • Workers’ Compensation Insurance
  • Health Insurance 
  • And of course, the dreaded FICA (Social Security and Medicare).
 
Enter the concept of the “1099 employee.”    It’s the best of both worlds.  Employees work in the business and are paid a flat amount.   No withholding, no taxes, and no matching their contributions to Social Security and Medicare.  Not to mention the reduced accounting and payroll-related expenses.  The worker is responsible for paying the employer’s portion of FICA in addition to their own withholding.  At the end of the year, instead of a form W-2, the worker receives a form 1099, which is what is given to an independent contractor for payments issued during the previous 12 months.  But is it legal?  The short answer is – for most people, probably not.   
 
Following COVID, the idea of employees working from home and a movement toward more of a “Gig” economy have led many employers to consider the idea of compensating workers via the 1099 route.  But with a variety of government agencies having a vested interest in making sure that employees are compensated and handled correctly, big brother is watching.   
 
The IRS 
The Internal Revenue Service has specific rules regarding who may and who may not be classified as an Independent Contractor.  An employee receives a form W-2 at the end of the year, but if the business issues a form 1099, the recipient must qualify as an Independent Contractor.  IRS Publication 15-A (The Employer’s Supplemental Tax Guide) gives a detailed description of who may be classified as an independent contractor, including common examples from a variety of industries for reference.   To qualify as an Independent Contractor for tax purposes, the IRS will use a Common Law analysis divided into three broad categories: 
 
  • Control.  Does the company control or have the right to control what the worker does and how the worker does the job?
  • Money.  Is the worker paid regularly or by the job?  Who provides the tools or equipment used in performing the services?  How are expenses handled?  
  • Relationship of the Parties.  Is there a written contract that describes the relationship and details of the work?  Is the worker hired for a specific job or a longer period?  
 
There is no single question that will determine independent contractor or employee status.  It is a facts and circumstances test.  But be cautious … generally the obligation is on the employer to prove that the worker is an independent contractor, and the IRS typically considers most workers to be employees.  If you have doubts about the status of a given employee, the IRS allows either the worker or the business to submit form SS-8, which will help to determine the status of the worker.   Improperly classifying a worker as an independent contractor can lead to having to pay back withholding, along with significant penalties and interest assessed by the Internal Revenue Service.  
 
US Department of Labor Rules
In early 2021, the US Department of Labor issued the Independent Contractor Rule whereby a 7-part analysis emphasizing an “economic realities test” is utilized in determining employee or independent contractor status for workers pursuant to the Fair Labor Standards Act (FLSA).  This rule made subtle changes to the then existing rules, making it easier to classify workers as independent contractors for purposes of U.S. Department of Labor issues (overtime rules, etc.)  Currently, a new rule is pending which has been submitted which brings the analysis back to a more skeptical look at those classified as independent contractors.  
 
North Carolina Law
The State of North Carolina has made a priority of ensuring that businesses properly classify workers as employees and not independent contractors.   The State of North Carolina’s authority in this matter deals with not only State tax withholding, but also matters such as Unemployment Insurance and Workers’ Compensation Insurance.   Effective beginning December 31, 2017, the NC Employee Fair Classification Act (EFCA) made significant changes to the monitoring and enforcement of the issue.   
 
Pursuant to the EFCA, the NC Industrial Commission (NCIC) created the Employee Classification Section which is housed with the NCIC’s Criminal Enforcement Division.  This Section is tasked with the investigation and enforcement of employee classification and is obligated to provide all relevant information involving employee misclassification to the North Carolina Department of Labor, the NC Division of Employment Security (NC Dept. of Commerce), and the North Carolina Industrial Commission.  
 
Currently, the NC Department of Labor utilizes the FLSA 7-part analysis and looks at: 
 
  • The extent to which the services rendered are an integral part of the principal's business.
  • The permanency of the relationship.
  • The amount of the alleged contractor's investment in facilities and equipment.
  • The nature and degree of control by the principal.
  • The alleged contractor's opportunities for profit and loss.
  • The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
  • The degree of independent business organization and operation.
 
Keep in mind that none of the above factors are completely dispositive and a total facts-and-circumstances test will be used.  
 
Misclassification in the State of North Carolina carries with it significant ramifications.   Penalties may include back taxes and withholding, substantial penalties and interest, and potential criminal ramifications including being charged with up to a Class H Felony for willfully failing to secure workers’ compensation insurance under N.C. General Statutes §97-94.  The stakes are high, and misclassifying employees in North Carolina is a dangerous proposition.  Couple that with the Internal Revenue Service knocking on the door of your business and the decision is simple.  If you find yourself on the fence between classifying a worker as an employee or independent contractor, seek the advice of your accountant and your attorney.  Because there is no such thing as a “1099 Employee.”  
 

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