The designation of Employee (w2) vs Independent Contractor (1099) is not up to free agreement between the parties. It has to follow regulations published by the IRS, DOL, and state authorities. Some business owners may consider independent contractors to be less expensive since there is no employer share of taxes, no payroll processing fees, no workers comp, etc. However, if there is misclassification, it can lead to litigation (e.g., independent contractor’s injury not covered by workers comp or no access to unemployment), fines and penalties from authorities, etc., so it could become an extremely costly mistake.

IRS Rules

  1. Behavioral control: A worker is an employee when the company has the right to direct and control the work performed by the worker, even if that right is not exercised.
  2. Financial control: Does the company have the right to direct or control the financial and commercial aspects of the employee’s work?
  3. Relationship: The type of relationship depends on how the worker and the company perceive their interaction with each other.

Link –  https://www.irs.gov/es/newsroom/understanding-employee-vs-contractor-designation

DOL Rules

  1. The extent to which the work performed is an integral part of the employer’s business.
  2. Whether the employee’s managerial skills affect his or her opportunity for profit and loss.
  3. The relative investments in facilities and equipment by the worker and the employer.
  4. The skill and initiative of the worker.
  5. The permanence of the relationship between the worker and the employer.
  6. The nature and degree of employer control.

Link –  https://www.dol.gov/general/topic/spanish-speakingtopic

State Rules

Each state has different rules and requirements for independent contractor and employee classification, so check your state’s guidance. Keep in mind that there are constant updates on this matter. You may recall the legal discussions about considering Uber drivers as employees versus independent contractors in California or New Jersey, which had significant consequences for the employer.

Please note that the authorities are enforcing employee classification because a) the IRS collects Medicare and Social Security during the year, while independent contractor is on quarterly estimates or at tax time for independent contractors, b) DOL wants to make sure the employer is not denying benefits and/or protections, c) states collect taxes from employees plus contribute to unemployment funds, disability funds, etc.

In certain cases, especially for independent contractors, our best recommendation is a clear agreement written and tailored by an attorney. At a minimum, there should be an internal memo (our custom template or similar document) addressing the authorities’ rules to avoid potential problems down the road.