Many small business owners like to save the hassle of withholding taxes from the paychecks of their workers, so they pay them their entire pay and issue 1099’s at the end of the year instead of W-2’s.  Are there any rules that determine when one can do this, or can each business owner decide on his own? 

 

 

Unfortunately for many business owners, there are statutes and case law that determine (in most cases) when a person can be classified as an independent contractor and when he must be considered an employee.  Obviously, the IRS would like all workers to be classified as W-2 employees because the employer then has to withhold taxes and pay them to the IRS every week or month; i.e. the employer is involuntarily doing the collection work for the IRS!

Many times the answer is unclear how a worker should be classified and one can successfully challenge the IRS’s determination that a worker is an employee rather than an independent contractor.  The basic question is one of control – i.e. how much does the employer control the worker.  The IRS has established 20 factors to consider when determining the status of the worker and some are more important than others.  Some of these are: does she have to work within specific hours; does she pay her own business expenses; does she provide her own tools or equipment; and is she free to work for others.  To summarize, the more control the employer has over the worker, the more likely it is that the IRS will classify that worker as an employee and force the employer to withhold taxes.