W-2 vs. 1099: The “Independent Contractor” Issue
Who and what is an independent contractor? Who decides? Who cares?
You care…if you’re a newly hired teacher looking for health insurance, or an employer trying to avoid the extra expense of withholding employment taxes, or an IRS agent conducting an audit! Whether an “independent contractor” relationship has been established has serious and potentially costly consequences for both the employer and the employee. In fact, even using the words “employer” or “employee” is problematic.
Employers are required to provide an income reporting statement for each employee. This form, W-2, must be filed with the employee’s income tax return. In addition to earnings, the form shows how much the employer has withheld for personal income tax, social security (“FICA”, that is, Federal Insurance Contributions Act) and Medicare contributions, and benefits such as vacation pay, retirement accounts, and insurance policies.
Independent contractors receive form 1099, an equivalent income reporting form. Form 1099, however, only shows gross earnings, because independent contractors aren’t subject to withholding and are not entitled to any benefits at all.
The independent contractor relationship does not favor the worker. Obviously it is to the employer’s advantage to retain the services of independent contractors: the employer is not required to contribute a share of the wage earner’s FICA; provide or offer to provide benefits of any kind; or go to the administrative trouble and expense of withholding personal income taxes. For that reason, the law protects the independent contractor by imposing strict criteria upon the relationship, primarily regarding supervision and control over performance of the task assigned. Although the relationship can be created by a contract which clearly articulates the intention of the parties, such contract is not binding on the taxing authorities and does not preclude an auditor from determining that the independent contractor relationship does not exist.
The painter you hired to repair your bedroom walls tells you that she will be there on Thursday at 8 in the morning and estimates that the job will be finished by 5 that afternoon. She will bring the paint in the colors you’ve chosen, tools, equipment, plaster and other materials, and she will bill you for the fee you’ve agreed to and her out-of-pocket expenses. You may tell her what to paint (the “task”) but you do not tell her how to paint. She is an independent contractor.
She sends Jimmy to do the work: she instructs him to appear at 8 A.M., leave no later than 5 P.M. without checking with her, and tells him to repair the nail holes with spackle, “skim coat” before he paints, use two coats of paint, and finish the moldings with enamel. During the course of the day, the painter stops by several times to see how Jimmy is doing. At 4:30, she notices that he’s painted over the hinges on the closet door, and threatens not to pay overtime if he has to stay an extra hour to remove the paint. Jimmy is an employee.
Unlike the house painter’s relationships with you and with Jimmy, the independent contractor relationship is usually not clear, and always subject to interpretation by the interested taxing authority. To establish a valid independent contractor relationship, the parties must be prepared not just to state, but to show, that the payer does not supervise or control the worker’s performance of the assigned task. A true independent contractor may create her own hours, work on- or off-site, provide her own tools and materials; the payer may not offer or provide benefits, sick leave or sick pay, vacation or compensatory time, or unemployment compensation.
Speak to your attorney about drafting a contract in which the intentions of the parties are unambiguous. Avoid buzz words like “employer”, “employee”, or “employment”. Stay away from language relating to hours, benefits, or supervision. Stick to describing the task to be performed, payment terms, and cancellation events. Remember, an independent contractor agreement is only as air-tight as the auditor says it is.