Taxes · April 29, 2021

Understanding the 1099 Employee Definition and How It Affects Businesses

When it comes to independent contractors doing freelance work, issuing and processing taxes can be tricky for a small business. Do you need a 1099 or a W2 form? Choosing the wrong form for your workers could lead to stiff fines from the IRS. Learning about independent contractor requirements, the 1099 employee definition and what characterizes an employee versus an independent contractor can help you make the right decisions during small business tax preparation time.

Employee or independent contractor?

With more small businesses looking for ways to streamline expenses and reduce legal responsibilities, hiring freelancers or independent contractors became a popular business trend in 2021. But unlike traditional employees, who receive a W2 form at tax time, independent contractors receive a 1099 form.

Before choosing between a 1099 form and a W2 form, you'll need to identify whether the individual works for you as an employee or an independent contractor. This is a little trickier than it sounds. That's because it's determined based on how work gets assigned and completed, rather than what you or the worker chooses to call your working relationship.

"The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done," the IRS definition notes. Any earnings of a person classed as an independent contractor, or 1099 employee, are "subject to self-employment tax."

Traits of an independent contractor

In addition to this broad definition, some independent contractor requirements can help individuals and businesses further determine whether a worker should receive a W2 tax form or a 1099 tax form. These include:

  • They provide specific services for projects or assignments as per a written contract.
  • The work is governed by a contract end date and specific project or assignment due dates.
  • How and when the work is completed is up to them, not the business they've contracted to.
  • Independent contractors may work on multiple contracts with multiple businesses at the same time.
  • They choose their own tools and methods for work and may also hire additional workers, as independent contractors may be classified as small businesses.
  • Independent contractors pay their own self-employment taxes as employer and employee.
  • They don't receive health benefits or other benefits from the businesses they contract with.

If you're confident that this describes the relationship your business has with the individual, you should issue a 1099 form.

W-2 form versus the 1099 form

If you're paying a worker a salary and benefits, as well as collecting and remitting taxes on their behalf, they're considered your employee for tax purposes. In this case, you'd issue a W2 form, which includes wage or salary information, plus details about the federal, state and other taxes withheld.

Use a 1099 form for independent contractors or freelancers who earned $600 or more from your business during the tax year. The 1099 form includes information on the total amount of money paid to the contractor, as well as their Social Security or other tax ID number. This notifies the IRS that they've earned money through a contract with your business. The contractor then is responsible for calculating and paying their own taxes based on their total annual income for the year.

If you review the independent contractor requirements and the 1099 employee definition and still find it challenging to determine the status and correct tax form to use for an individual, reach out to the IRS for help. File Form SS-8 (PDF), the Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, to get assistance with correctly identifying which form to use.

When it comes to independent contractors and standard employees, it's important to know which form to use at tax time. Understanding some of the key documentation and employee statuses can help you make the right choice when completing forms, helping you simplify the process and better understand your business's financial situation.


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