| 19 January 2011
This question comes up often. Usually, it’s because someone comes into my office for tax preparation only to realize that they were not treated as the employee that they were originally hired to be. Their employer has opted to give them a 1099M instead of a W2. Why would they do this? What are the benefits to the employer? Are there any benefits to the employee? How does a 1099M differ from a W2? Let’s take a look at some of the answers.
This is what the IRS defines as a contract laborer:
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The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.
Example: Vera Elm, an electrician, submitted a job estimate to a housing complex for electrical work at $16 per hour for 400 hours. She is to receive $1,280 every 2 weeks for the next 10 weeks. This is not considered payment by the hour. Even if she works more or less than 400 hours to complete the work, Vera Elm will receive $6,400. She also performs additional electronic installations under contracts with other companies that she obtained through advertisements. Vera is an independent contractor.
By contrast, this is how they define an employee:
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Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.
Example: Donna Lee is a salesperson employed on a full-time basis by Bob Blue, an auto dealer. She works 6 days a week, and is on duty in Bob’s showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager’s approval. Lists of prospective customers belong to the dealer. She has to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and in other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Bob. Bob also pays the cost of health insurance and group-term life insurance for Donna. Donna is an employee of Bob Blue.
It is important to understand the difference between a contract laborer and an employee because to misclassify an employee as a contract laborer could be a costly mistake for the employer.
Some of the benefits to the employer in hiring someone on a contractual basis are that he will not be burdened and obligated to file quarterly payroll taxes for that person. He will not withhold taxes from this person’s compensation to cover their federal income tax, Social Security tax, Medicare or unemployment taxes. The person being contracted must take care of paying all these taxes on his own. He is considered, by the IRS, to be self-employed. Also, the employer saves monetarily on the employer’s portion of the self employment tax that he would otherwise be obligated to pay on behalf of his employee. The employer would rightly issue this subcontractor a 1099M at the end of the year showing all monies paid.
Since he is considered self employed, the sub-contractor can deduct from taxable income all ordinary and necessary expenses in the course of his work. Obviously, the major disadvantage to the one hired for services lies in his responsibility to pay all of his own taxes. Additionally, he must keep really good records in order to accurately file his tax return. The self employed sub-contractor must also take into account the issues of retirement planning and health insurance. There are many more details that we can get into, but these are the basics.
Employers can run into problems when they misclassify an employee as a contract laborer and issue them a 1099M instead of a W2. Employees who have no means of paying their burdensome tax bill have the option of filing IRS form SS-8 if the employer refuses to correct the issue. Form SS-8 asks the IRS to make a determination as to whether or not you qualify to be classified as an employee or self-employed. They will decide. If the IRS determines that an employee relationship exists, then the employer may be liable for ALL of the employment taxes (Social Security & Medicare) that should have been withheld from the employee’s payroll. The employer will probably have to pay penalties and interest as well. As you can see, it pays to know the rules and to play by them. To do otherwise can lead to headaches with the IRS.
Esther Hastings is President/CEO of E-File Florida, LLC located in Davie, FL. E-File Florida has been helping taxpayers and small business owners to maximize their tax refunds for over 19 years. E-File Florida firmly believes that the best way for anyone to legally and legitimately reduce their tax liabilities is to know the tax rules and how these rules pertain to their particular situation. “When you know the rules, then you are positioned to use them to your advantage!”
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