Employee or contractor?
You’d better know.
February is the month when companies issue 1099 forms, and it is a good time to revisit the justification for issuing them to people who might be viewed as employees.
There are books of regulations from both the federal and state governments on the issuance of a 1099. The governments are worried about the loss of revenue in both the Social Security Trust Fund and the state unemployment funds, so they are prepared to do desk audits and in-person audits. It is one of the largest untapped sources of revenues, and neither the state nor the federal government wants to leave it untapped for long.
I will give you a sense of the rules below, but I think first, we should talk about the tax loss part of this issue.
People who are self-employed pay 13.3 percent in so called self-employment tax. This tax goes into the Social Security Trust Fund. If an employee is misclassified as an independent contractor, the trust fund loses 2 percent. That is assuming that the “1099 employee” actually does file a return as an independent contractor.
The loss to the government can be considerable. If an employee makes, say, $60,000, the difference between an independent contractor and an employee is $1,200. That assumes that all of the filing is done properly.
The state unemployment fund is also “cheated” when an employee is an independent contractor. Many do not file unemployment returns with the state at all, thus leaving the fund short as well. The balance in the Vermont fund has been going down over the past few years and is projected to be going down over the next several years. The state trust fund balance has fallen over the last seven years by about 40 percent.
Having a healthy balance in the fund is essential to the state’s financial health in the event of a recession. Benefits will be paid no matter what, but if Vermont experiences a recession that kicks the unemployment rate above 4 percent, the fund balance can plummet. The Department of Labor is projecting that the balance will continue to drop over the next 10 years and will be just over $50 million in 2016 — compared to about $175 million today. That assumes a 4 percent unemployment rate and rising benefits for beneficiaries.
So ... where does all of this take us?
There will be increased scrutiny of 1099 “employees” in the future.
How do we tell if we should treat someone as an employee or as an independent contractor? There is a whole list of criteria listed on the IRS website, but there is one main theme that runs through it all: direction and control.
To put this in another way, Who is in charge?
If a company tells a person what time to come to work, where to sit and what to work on, that person is clearly an employee. If the company supervises the work in any way, the person is an employee. It is that plain and simple.
That means that your attorney, your accountant and even your advertising agency are not employees. You do not direct your attorney’s work; you just ask questions or seek opinions, in most cases. Your direction is really limited to what issues the attorney will work on; you do not control his or her schedule, when to work on your information or how to do it.
If your company is one of the comparatively few that have in-house counsel, you would control the hours of work, the place of work and specific work issues. With that, the attorney would then be an employee.
But these are extreme cases. For the most part, employees are just that — employees — and they should be treated as such. They should receive all the rights and privileges of an employee and you (and the employee) should pay the appropriate taxes and withhold the appropriate amounts from their pay.
Next time, I will talk about an even more onerous form of employment: paying under the table. •
Dave Mount is the owner of Westaff in Burlington.