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Importance of the 1099 vs W2 classification

Posted by Admin Posted on Sept 02 2015

It seems that every couple years the IRS has a new focus and this year we hear that the big focus is on misclassification of 1099 vs W2. What this means is that if you “employ” someone but pay them as a contractor and issue them a 1099 at year end, you could be misclassifying them. Misclassification can deny workers the rights and protections to which they are entitled as an employee and it reduces tax revenue collected by the federal and state governments. For these reasons, federal and state agencies have identified misclassification of employees as independent contractors as one of their top enforcement priorities.

 

In general an employee is a worker whose activities are directed by an employer, while a contractor is normally more at arm’s length and left to perform at their own discretion.  There are rules and guidelines for when a person is an employee or a contractor which can get quite technical, so we recommend getting clarity on this before it is too late. The penalties for misclassification can be significant. In addition to owing back pay, overtime, and benefits to a misclassified worker, the employer may be ordered to pay back taxes, interest, and fines. In some states, employers that intentionally misclassify a worker may also face  criminal charges or stop-work orders.

 

This may even affect people who operate their businesses as “S” Corporations. One of the rules the IRS has for self-employer “S” Corporations is that the owner take a reasonable salary. Often this is accomplished by the owned simply taking 1099 income for his or her salary (which should be 50% of the corporation’s income). This results in the owner accounting for self- employment taxes at year end. However, it is quite conceivable that given the loss of cash flow to the government during the year, this could be included in the IRS focus and penalties levied because these self-employment taxes should be paid over monthly or quarterly.