It is almost too easy to make this mistake. And sadly it is one that small business owners and untrained managers make too often, without realizing the liability that a back payroll tax audit. It only takes one government agency, such as a state unemployment agency to tell you “sorry, they are actually an employee and you owe us back unemployment taxes”. Ouch. The next phone call might be to the IRS to hit your business with back Social Security taxes. Double ouch.
Rather than fearing the worst case scenario, and hoping that your desire to keep payroll costs down ends up costing you even ore in the longer, let’s agree to minimize risk. 1099 is just simple way to say vendor. Not an employee. Not a staff member. They are an independent business entity, whether it is one individual or a small LLC with a team of professionals to access. Just like your business can sustain a profit or loss, so can the 1099 or independent contractor.
If you have identified a need to “contract” with a person or entity that will be 1099’d at year end, forget that “20 Point” test let’s embrace some simple steps to follow:
- Is the need you have identified all the primary service your company offers? If the core service of your business is computer repair, then you generally would not categorize your technicians as 1099. If your company provides after hours answering services, then those who answer for the phone for customers should be 1099. To qualify as 1099 without back payroll tax or other liability your business should not rely on a contractor as a major portion of your businesses success.
- If you have cleared step 1, step to is to find the vendor? Be referred, do a Google Search, put an RFP out on Craig’s List. Yes, an RFP. You are looking for a vendor to propose to your business how what they do will satisfy your need and what their terms are. This is very different from hiring an employee how will be paid through your payroll. If you vet them and want to move forward then….
- Enter into a Service Agreement. Or call it a Contract. Initially the Service Agreement terms will be proposed by the vendor (1099) and you can decide to sign and accept or negotiate out a few items. but some key points with that Service Agreement: Be sure it clearly states the individual or company is a contractor never an employee; Highlight the contractor’s autonomy and level of authority in complete a project or rendering services; List circumstances that would cause termination of the agreement; Be sure the contractor commits to keeping their licenses and insurances current through the course of the agreement; No exclusivity! A contractor should be free to work with other “clients”.
- Require the chosen contractor to prove their existence as a business entity! Ask for a copy of a current business license and any proof of insurance you deem necessary to feel comfortable. Typically that would be proof of E & O coverage for certain consultants and proof of Worker’s Compensation Insurance or other similar business insurances you need to be aware to be comfortable outsourcing work to them.
- If paying the Vendor (1099) more than $600 per year, ask them to provide a signed W9. This will contain their Federal Tax ID number so you can properly process that 1099 at year end, so income earned by that business entity (1099) is correctly reported to the IRS.
Once you begin working with this Vendor, some Do’s and Don’t;s:
- Do not set their hours. You tell them what needs to be done and they do it according to their own proposed terms, their schedule and their own staffing decisions.
- Do not evaluate the Vendor or Providers performance like you would an employee. If they violate the terms of the Agreement or Contractor, end it in accordance with the terms you agreed to.
- Do allow them to use their own tools, their own equipment. They are a professional business entity with their own supplies.
- Do not pay for their benefits or attempt to put them on any of your group benefit plans.
- Do not require them to be at your workplace or attempt to integrated them into your primary operations.
- Do require a copy of a business license and proof of insurances.
- If happy with services rendered do keep renewing an Agreement. Perhaps every couple of years. An ongoing relationship with a 1099 should never be written or implied.
- Do treat a 1099 as Business Owner and not an employee.
Why do all this? Because the last thing you or your business wants or needs is the State Unemployment Office or worse, the IRS auditing you for failure to pay payroll taxes and you don’t want a “contractor” injured while working for your company trying to collect Worker’s Compensation benefits under your policy.
Be inspired to minimize risk! It will protect your P & L and maybe even help you sleep better at night.