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Hey everybody. This is Gene Marks. And welcome to this week’s edition of The Hartford Small Biz Ahead. This week we’re gonna talk about worker classification rules: 1099 workers and independent contractors. Last month, a U.S. district of court down in Texas stopped the Biden Administration’s efforts to roll back a Trump error role that made it simpler for employers to classify workers as independent contractors. The reasons were actually due to a procedural mistake, but the decision, it was a victory for small businesses across the country who otherwise would’ve had to classify more independent contractors as employees, but my warning to, if you’re listening and you’ve got 1099 workers like I do, that classification battle is far from over. According to some reports, The National Labor Relations Board recently indicated an openness to revisit worker classification rules.
And the Department of Labor is also evaluating all legal options, including the potential need for rule making. Solicitor of Labor SEEMA Nanda had this to say about the district court’s opinion: “The district court decision is both surprising and disappointing, she said. “When employers misclassify workers as independent contractors, workers lose key rights and protections hurting labor standards across the board and making it harder for law abiding employers to compete on an even playing field.” So listen, all of this discussion, all of this debate about 1099 workers, the implications for small businesses like yours and mine are pretty significant. Hiring an independent contractor instead of an employee means that business owners like ourselves don’t have to incur payroll taxes or pay additional employee benefits or be subject to certain employer, employee responsibilities, particularly for like safety and health rules. So as the Biden Administration takes a harder look at these rules, it’s important for small businesses, that’s you and me that use independent contractors to know our risks and the risks of non-compliance can be pretty significant.
One attorney told me that small business owners really need to be careful because from a worker classification perspective, there are multifaceted opportunities to be challenged. There are multiple federal agencies, including the IRS and the department of labor that can come after both of us for improper classifications, which can have enormous consequences on wage withholding, social security, workers compensation insurance and unemployment payments. I also talked to another advisor, another expert who used to work for the city of Philadelphia as a tax solicitor. Her name is Nikki Johnson-Huston and she told me that it’s not just the federal government business owners have to be worried about if you’re not in compliance with these worker classification rules. I mean, both your state and potentially your city or locality can also have an interest in what’s going on. She said that with the advent of better technology and better systems, all the taxing authorities like share information with each other.
And you gotta be aware of that if you do get reassessed and your city or your state finds out, there could be significant fines and penalties. She told me, she’s seen some companies get put out of business because of misclassifying workers, depending on how long the situation occurred. She said there could be tens of thousands, if not hundreds of thousands of dollars of fines per employee. And then once one tax entity finds out. It’s like, they’re gonna share that information. Then they’re all gonna want that pound of flesh. Those were her words. So how can you make sure that you’re classifying your employees or independent contractors correctly? On the IRS’s website, we can provide these in the notes to this episode. The IRS does provide rules. The Department of Labor also has its own rules and guidelines.
Both of these sets of rules mainly focus around one important aspect of the employer worker relationship. And that aspect is control. What you’re really looking at from an IRS perspective is the independence of those workers and the ability that have to exert independent control over their activities and over the end product. So this means that to be properly classified as an independent contractor, the workers must have complete control over the work they’re performing, the hours worked, where are the work is performed, the tools they use and the people that they may employ. Although only social security numbers required to report a contractor’s payments on the federal form, 1099 each year, the contractors should preferably provide an employee identification number an EIN, and should also have multiple customers, in addition to your company. Your relationship should be arms length and in no way should the contractor be included in your payroll calculations or be offered any benefits that an employee receives. In fact, this person that should be running their own independent business that is invoicing you and your firm for their work performed.
One of the things that everyone needs to understand is that the government, whether it is the department of labor, the IRS, they presume that everyone is an employee until the company shows them otherwise. Now you also wanna have an independent contractor agreement and this should be signed by all parties and it should be updated regularly. The agreement should stipulate both the workers and the employer’s responsibilities. There are some good examples of this that you can download from LegalZoom.com or RocketLawyer.com. Those are just a couple of nice sites that have some good examples of 1099 agreements. They have to be filed annually with the IRS state and city. Getting help from a tax attorney or a certified public accountant is also a good idea if your firm uses independent contractors. So be warned even when a contractor provides all the required information, though, you still have to be careful.
It’s not the woman that I talked to Ms. Johnson-Huston, said that she has seen cases when working for the city of Philadelphia, where an employer is audited, even when fraud was committed by the contractor. A lot of times when an individual problem is found, the authorities may start thinking, “Hey, this might be a larger issue and they can start pulling more records for that business.” And even if you’re completely in compliance, the cost of an audit could run into the tens of thousands of dollars. So given the cost savings and lower regulatory requirements, it is really tempting for small businesses to avoid hiring employees and instead use independent contractors. And look, I do that myself. I have both, there’s nothing wrong with this. Like I said, I do it all the time. But in this current pro-worker environment, both in Washington and locally, it is important for us to make sure that we’re in compliance with the rules.
Even as they change, one attorney I spoke to said “I expect a continuation of heightened enforcement of existing rules.” He is right. This is a hot button issue. And small business owners should be extra cautious in this area because the enormity of the exposures that you can have for making the wrong decisions. So look, I don’t wanna discourage you from having independent contractors in your business. There’s 1099 workers. In fact, for many of them that are freelancers, it’s an entrepreneurial opportunity. Be careful comply with the rules, have independent contractor agreements, make sure that you are not exerting influence and control over them and check them out as well. Make sure they have an EIN, an employer identification number. And you’re not their only customer, take the right steps. And if you’re in compliance with the rules, you can certainly have independent contractors.
Just be careful though, because the government and I mean, both the federal and state and potentially your local governments are really keeping a close eye on this stuff. And those rules themselves are going to be changing. Hope you found this information helpful. Again, you’ve been listening to the Small Biz Ahead podcast. You can visit us at Smallbizahead.com. If you would like any advice, tips or thoughts on helpfully running your business that much better. My name is Gene Marks. Hopefully you’ll join us for our podcast that I do with Jon Aidukonis here. And we will be back with you next week with another Small Biz Ahead podcast to help you run your business. Take care and see you then.
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