With contract employment on the rise, an increasing number of businesses are looking to hire specialized workers on a contingent basis as a way to save money, reduce risks and liability, and maintain a flexible workforce. At the same time, more employees (or those looking for employment) are classifying themselves as independent contractors, preferring the flexibility and autonomy these project-based employment opportunities provide.

While contract placements can provide recruiters and staffing firms with a lucrative source of income, they can also raise confusion when it comes to what is (and isn’t) legal 1099 classification. Companies wishing to hire a contract employee may not actually understand the necessary job specifications that make up a 1099 position, while prospective employees cannot legally classify themselves as “contractors” just by saying so. Misclassifying employees can have serious legal and financial repercussions for businesses, recruiters, and employees. However, many continue to make the same mistakes time and again – and pay a hefty price for doing so. The fine for an intentional misclassification can be a penalty equal to 100% of the amount in taxes owed. In cases where an employer negligently reports or under-reports employee status, the IRS can impose a 20% accuracy-related penalty. What’s more, the IRS has recently taken special interest in worker classification, and has raised the number and amounts of the fines and penalties in an attempt to stop these mistakes once and for all.

Now more than ever, it’s important for recruiters and their clients to understand the ins and outs of contract hiring. Though the penalties for incorrectly classifying employees are steep, they can be avoided by knowing the differences between employee classifications.

What defines an Independent Contractor or W2 Employee?
The easiest way to avoid employee classification errors is for employers to maintain a clear understanding of the factors that determine an employee’s status as 1099 or W2, and the differences between them. One simple way to determine the appropriate status of a potential contract worker is to check for, as the name implies, the existence of a contract. A 1099 position must include a contract with a very specific end date. The worker is free to set their own schedule, and is only responsible for completing the project by the date specified in their contract. On the other hand, a W2 employee has a set schedule of work hours managed by the employer and has no specified end-date of employment. Essentially, a 1099 contractor is paid on a project basis, whereas a W2 employee is paid based on hours worked. Other more specific differences between 1099 contractors and W2 employees are laid out in the IRS’ guide for determining employee classification.

The IRS Guidelines Under the IRS’ test, workers are considered employees if the company they work for has the right to direct and control the way they work – including the details of when, where and how the job is accomplished. In contrast, the IRS will consider workers independent contractors if the company they work for does not manage how they work, except to accept or reject their final results.

In making its determination, the IRS looks at a number of factors, including whether a worker:

• Is paid by the job or by the hour
• Furnishes the tools and materials needed to do the work
• Sets his or her own working hours
• Is told in what sequence or order to work by the hiring company
• Receives training from the hiring company
• Works full-time for the hiring company
• Works for more than one company at a time
• Invests in his own equipment and facilities
• Pays his own business and travel expenses
• Hires and pays assistants
• Provides regular oral or written progress reports to the hiring company
• Provides services that are an integral part of the hiring company’s day-to-day operations

If, based on this checklist, the IRS would likely consider the employee an independent contractor, it is not necessary to withhold federal payroll taxes for the worker, including Social Security taxes, federal disability taxes and federal income taxes. If the IRS would not consider the worker an independent contractor, however, it is absolutely necessary to make sure all of these taxes are accurately withheld.

Another piece of advice: when placing more than one employee at the same company in the same position, make sure that both workers are classified the same, whether 1099 contractors or a W2 employees. Too often recruiters will place two or more employees in the same type of job, classifying one as a 1099 contractor and the other as a W2 employee. If the job descriptions are the same, the classifications must match as well. Doing otherwise raises compliance issues, and will likely also raise a red flag for the IRS.

Correcting classification errors
If a recruiter realizes he or she has been misclassifying employees, there is no need to panic, but corrections should be made as soon as possible. The best thing to do is identify the errors and then make the changes going forward. If necessary, consult an employment law expert or HR specialist to make the necessary corrections. Innovative Employee Solutions has a great deal of expertise in 1099 tax laws and IRS compliance, and regularly provides recruiters and staffing firms with guidance and counsel regarding such issues. A simple phone call may be all it takes to clear up any questions and avoid potentially hefty penalties down the line.

Since misclassifying employees can cost a recruiter, staffing firm, or even a client company a devastating loss of time, effort and money, it is essential to stay educated on the causes and how it can be prevented.

The confusion of classifying workers in accordance with IRS standards can also be avoided by hiring an outside payrolling company to act as the legal W2 employer of contract workers. This process can be a huge benefit to recruiters, because of the many questions and confusion surrounding classification. By outsourcing payroll for contract workers, recruiters can lower their risk of misclassification, avoid the time-consuming process of staying up-to-date on employment laws, and ultimately get back to what they do best: recruiting the right talent for their clients.