Are your Sub-Contractors Really Employees?

Hiring sub-contractors, also called 1099 contractors, independent contractors or even 1099 employees, can be beneficial to small businesses. These vendors can provide highly skilled services, can give your company flexibility in handling changes in work-flow, and there is the potential for cost savings over hiring an employee.

However, it can also be quite detrimental if not done properly. The Federal Department of Labor, most State Departments of Labor and the IRS have defined what they deem to be independent contractors, if the criteria are not met, then they are employees.

So, how do you know if you’re risking significant fines & penalties from one or multiple agencies? Well, you need to familiarize yourself with the criteria of all three agencies. However, there are some common criteria that may help you decide if you need to further investigate your classifications.

1. Does the service provider provide services to multiple businesses, not just yours? Are they set up as a business (registered with your state, is covered by business insurance, etc.)?

If so, then you can most likely stop right here. You have hired an independent contractor. To make sure you are fully covered in case of a Labor (or even a Worker’s Compensation) Audit, I would encourage you to collect Certificates of Insurance from all your independent contractors (any person or company that you will be providing a 1099-MISC for in January).

2. Does the service provider control how, when & where the work is completed?

If you require the service provider to come into the office at specific times, for a set number of hours, and they must do the work your way, then you may be treading on dangerous ground. I would suggest you speak to an attorney who works in the employment law arena to see if you are indeed misclassifying employees as contractors.

3. Does the service provider provide all tools, supplies, etc. to complete the job?

If the service provider supplies the tools, office supplies, or machines (office or otherwise), without requesting reimbursement from you, then you are most likely in independent contractor territory.

4. Does the service provided dictate the amount of financial compensation for the job?

Who set the compensation amount? If the service provider dictated to you the fees that would be charged to complete the job and the schedule for payment of those fees, again you are closer to independent contractor territory.

5. Are they a former employee? Whose choice was it to become a former employee?

If the service provider left your employment to pursue starting their own business and you valued their work enough to have them continue as an independent contractor holding to the above listed criteria, then you again are most likely ok. However, if you chose to end their employment and then offered them work as an independent contractor, but continuing to set the how, when & where expectations, then you may want to reconsider their classification and bring them back as a part-time employee, or look for another solution to get the work completed as you have most likely misclassified them and are risking high penalties & fines.

This is not a complete list of the criteria, but just a starting point. I would strongly suggest speaking with an expert such as your CPA and/or attorney, to confirm that you are in compliance with your employee classifications. An experienced, qualified and knowledgeable bookkeeper can also be a great resource in this area, but you want to make sure they have payroll experience and are up on the current labor laws both federally and in your individual state.