Contributed by: PhillipB, FreeTaxUSA Agent, Tax Pro
Many businesses choose to issue Form(s) 1099-NEC instead of Form(s) W-2. This makes sense for people who want to be treated as running their own business. But for others, it can be confusing and frustrating. Some taxpayers are shocked because they don’t understand why they got a 1099 or what it means to be self-employed instead of an employee. If this happens to you, the difference in your taxes can be a big surprise. You may wonder if the business is allowed to do this and if there's a way to have the 1099-NEC changed to a W-2.
How does the IRS define who’s an employee and who’s an independent contractor?
The first step is to understand who an employee is, and who’s an independent contractor. The IRS provides a couple of simple definitions for each and some guidelines to figure out which kind of worker you are.
- Employee: Someone who works for a business and the business controls how the work is done. Even if you have some freedom, you’re still an employee if the company tells you how to do your job.
- Independent Contractor: Someone who controls how and when the work is done, even if the business controls the final result.
Does the IRS provide additional guidance?
To further narrow down whether someone is an employee or an independent contractor, the IRS has provided three main factors to consider in making the correct determination. Those factors are as follows:
- Behavioral:
- Does the business control what the worker does, and how the worker does their job?
- Financial:
- Does the business control how and when the worker is paid?
- Does the business reimburse the business expenses of the worker?
- Does the business provide the worker with their tools and supplies?
- Type of relationship:
- Are there written contracts?
- Are there employee-type benefits paid by the business, like health insurance?
- Is there an on-going relationship after the work has been completed?
Businesses are required to consider all these factors in determining how they’ll pay the people who work for them. There’s no single factor or set number of factors that will determine the answer one way or another. The entire relationship and the business’ right to direct and control its workers must be considered.
NOTE: Businesses do have a safe harbor for treating people as independent contractors even if the factors listed above lean in favor of the workers being classified as employees. Under the 1978 Section 530 Employment Tax Relief provisions, a business may continue to treat those workers as contractors if all the following apply:
- The business has consistently filed the required information returns for their workers. This means they don’t miss filing their Forms 1099-NEC or 1099-MISC.
- The business has never treated any of the same kind of workers as employees. For example, a cleaning business that issues 1099-NEC forms to their cleaners must have never paid any cleaners as employees.
What can I do if I'm sure that I am being misclassified as an independent contractor?
Ideally, you and the payer agree as to whether you’re an employee or a self-employed contractor at the beginning of your business relationship. If there’s a job offered on condition of being paid as an independent contractor, you likely should only accept the job if being self-employed is acceptable to you. It’s best to negotiate this issue at the beginning.
However, if you’re in the situation where you were paid as an independent contractor and you want to disagree with that classification, you can ask the IRS to decide this matter for you and the payer by doing the following:
- File Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding with the IRS.
- File your tax return using Form 8919, Uncollected Social Security and Medicare Tax instead of reporting the income as business income on Schedule C.
The IRS will contact the business to examine the issue. After they make their determination, they'll let you know the outcome and either require the employer to pay their share of your social security and Medicare tax or they'll contact you and recalculate your income as self-employment income and make you pay the unpaid portion of self-employment taxes.
It would be a good idea to have a record of any expenses you incurred for the job throughout the year. If the IRS determines that you’re self-employed after the SS-8 audit is finished, you could use your business expense records to amend your return and deduct your business-related expenses against the income on Schedule C.