1099 vs W-2: New Guidance for Classifying Workers

Could tax filing get any more complex? With each passing year, a fresh set of codes and nuances emerges, challenging small business owners to stay ahead. This year is no exception, especially with significant updates in worker classification that could impact your filings. 


The spotlight is on the ever-evolving distinctions between 1099 and W-2 classifications; some of these changes might work in your favor. This article explains the details of 1099 vs. W-2 and describes the latest shifts that are making waves this filing season.


The New and Final Rule on 1099 vs. W-2 Classifications


On January 10, 2024, the Department of Labor (DOL) unveiled a pressing update titled “Employee or Independent Contractor Classification Under the Fair Labor Standards Act.” This rule provides businesses with guidance to determine if a worker is classified as an employee or an independent contractor. The significance of this distinction cannot be overstated, as misclassifying an employee as an independent contractor can result in substantial penalties.


Effective as of March 11, 2024, the rule aims to reduce the risks associated with misclassification. A notable change is the introduction of six factors for classifying workers, expanding from the previously recognized two. It is important to understand that meeting all six criteria is not mandatory, which contributes to the current buzz and potential confusion surrounding the topic. The significance lies in the interplay of these factors rather than in any single criterion.


6 Factors for Classifying Workers


The rule introduces six key factors to help determine the correct classification of workers:


1. Opportunity for Profit or Loss Depending on Managerial Skill 

This factor evaluates whether the worker can set their own rates, choose which jobs to take on, and manage their work schedule, all of which can influence their business’s profitability. For instance, a house cleaner who determines their charges, cleaning schedules, and marketing strategies might qualify as a 1099 contractor. Conversely, if these decisions are made by the employer, the worker would more aptly be classified as an employee.


2. Investments by the Worker and the Potential Employer

Independent contractors often invest in the tools and equipment necessary for their work. For example, a fitness trainer working independently would need to provide their own equipment, which would distinguish them from a gym-employed trainer who uses the gym’s facilities and equipment.


3. Degree of Permanence of the Work Relationship

An ongoing, exclusive work relationship typically indicates employee status in the 1099 vs W-2 distinction. Consider an executive assistant; if they serve a single client exclusively, they lean towards being an employee. However, maintaining multiple clients can preserve their status as an independent contractor, regardless of whether the work is part-time or full-time.


4. Nature and Degree of Control

This factor examines whether the employer sets the worker’s schedule, supervises the work closely, or applies a rewards and penalties system. For example, a Social Media Manager working under a contract without receiving performance-based bonuses operates more like an independent contractor, fulfilling agreed-upon tasks without direct oversight of how those tasks are completed.


5. Is the Work Performed an Integral Part of the Business

Employees are often vital to a business’s daily operations. An HR Manager responsible for payroll and employee benefits, for example, is integral to the company’s function and would typically be classified as an employee.


6. Skill and Initiative

Workers who utilize specialized skills to demonstrate business initiative may be considered independent contractors, especially if those skills do not require extensive training specific to the business. A web developer, for instance, may be viewed as a contractor unless their role evolves to include training employees or performing tasks that align closely with the company’s primary services.


Penalties for Incorrect Classifications


Misclassifying workers as independent contractors instead of employees can have significant legal and financial consequences for your business. Understanding the penalties associated with this is important to ensure compliance with labor laws and to protect your business from costly fines and liabilities.


• Wage Law Violations: If the Department of Labor finds that a worker has been misclassified, your business may be liable for back wages due under the Fair Labor Standards Act (FLSA). This includes overtime and minimum wage payments not provided to workers under their incorrect 1099 status.

• Unpaid Employment Taxes: Misclassification leads to due taxes, including the Social Security and Medicare taxes that employers must withhold and pay on behalf of their employees. The IRS can impose penalties and interest on these unpaid taxes, increasing the financial burden on your business.

• I-9 Violations: Employers must complete and retain Form I-9 for each individual they hire for employment in the United States. Misclassification can result in violations of these requirements, with penalties for failing to properly document and verify an employee’s eligibility to work.

• Unemployment Insurance Fees: Employers contribute to unemployment insurance for their employees. You may be responsible for paying back unemployment insurance fees, penalties, and interest.

• Workers’ Compensation: Misclassified employees may be excluded from workers’ compensation coverage, leaving your business exposed to lawsuits for workplace injuries. If a misclassified worker is injured on the job, you could be responsible for their medical expenses and disability benefits.


The fines for misclassification can be steep, varying based on the nature of the violation and whether the government perceives the misclassification as intentional or accidental. An audit could require you to substantiate your classification decisions. 


Key Takeaways


The distinction between 1099 and W-2 workers is a critical aspect of running your business. This information requires your attention and understanding. The Department of Labor’s new rule is now in effect. It is the perfect time to review your worker classifications and ensure compliance. Utilize the available resources and tools to navigate these changes smoothly. This will help keep your business in line with labor laws and regulations.


Additional Information on 1099 vs. W2


1. IRS Small Entity Compliance Guide

2. Karen Moss from HR Ins and Outs

3. Tax Bandits dives into the numbers


How FINSYNC Can Help


There are 3 primary ways FINSYNC helps business owners. (1) CO.STARTERS courses through FINSYNC can help turn your business idea or side hustle into a thriving business. (2) On our website, you can also apply for a business bank account. (3) In addition, the FINSYNC software allows you to run your business on One Platform – invoice customers, pay bills, process payroll, automate accounting, and manage cash flow. To learn more about how we can help your business start, scale, and succeed, contact us today.


Helping small businesses is our core mission at FINSYNC.

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