Workers’ Compensation and the 1099 MYTH

Workers’ Compensation and the 1099 MYTH

October 28, 2015

At one time or another, almost every business owner will have to confront the decision of hiring employees. The first step in deciding whether or not to grow the business would be the cost to hire an employee(s). This is where things often get complicated and the wrong decision can be very costly. To learn more about what the requirements are for your industry there are two places to look, our website and the Chief Financial Officer’s site. I would like to note that just because you are not required to carry workers’ compensation does not mean the you should not carry workers’ compensation. If you have one employee you can be held liable for anything that happens to them in the course of business. For that reason, I believe all business’ with one or more employees SHOULD carry workers’ compensation.

Now that you have determined you are required to carry workers’ compensation, the next step should be working to get a policy. However, in many industries people are under the impression they can pay the workers on a 1099 form instead of a W2 and not be required to carry workers’ compensation insurance. What does this mean? Someone paid on a tax 1099 form is considered an independent subcontractor, not an employee. Therefore, if you are paying someone in that form, workers’ compensation would not be required because they are a subcontractor, not an employee. This is where it becomes very complicated.

Just because you pay someone on a 1099 form, does not mean you are free from liability and should not carry workers’ compensation. Here is a real life situation for reference:

A small dry cleaning business is getting busy and needs some part time help. In trying to protect himself from being liable, the part time worker would be paid as a subcontractor on a 1099 form. While working under the direction of the owner she slips, falls, breaks her leg and needs surgery. The part time worker sued the owner for damages and won. Why did this person win if they were a subcontractor? Because they were acting in a capacity of an employee and not a subcontractor.

There are five factors that can help determine if the individual(s) are employees or subcontractors, they are:

  • Right to Control
  • Character of Work Is the Same as the Employer
  • Method of Payment
  • Furnishing Equipment/Materials
  • Right to Hire/Fire

The Right to Control refers to the direction and control the person or organization exerts over a person(s) performing a task. In an employee situation, the person/organization hiring would set the parameters of work and specifics in which the job would be performed. The employee would be working under the authority of the employer. In a true subcontractor situation, the subcontractor would be hired for a job (i.e. lay tile in a new home) and would be performing the task under their own direction, timeline, and method of laying the tile.

If the Character of Work will refer to the relationship between the person/organization and individual(s) hired to perform work. The example of an employee would be a heating and air contractor hiring an individual to run the ductwork in a new home. This individual works on a regular basis performing a similar tasks for the hvac contractor. The true subcontractor example in this case would be a general contractor building a new home. He hires a heating and air contractor to do the work in one home and may or may not work for him again.

Method of Payment is referring to compensation of work performed. An employee would typically be compensated hourly, daily, weekly, monthly, etc. A subcontractor would be paid a flat fee for for the work performed. Although the subcontractor may perform more than one job, the income is typically generated from different individuals/organizations.

Furnishing of Equipment and/or Materials is usually provided to an employee. They would show up for work and use the equipment the employer already has onsite. A subcontractor will have their own tools, equipment, and machinery to perform their specific task. Understandably, there could be some overlap here.

Right to Hire/Fire individuals/organizations will typically be relegated to an employer/employee relationship. Although a subcontractor can be dismissed from a job, it is related to the inability to complete a task or perform to the specifications of the contract or agreement. A subcontractor has control over the work they do and has the freedom to complete the job however they see fit, as long as they fulfill the obligations. An employee may be fired simply for not performing the exact way the employer set forth, regardless of whether wrong or right.

If you are still unsure whether you have an employee or subcontractor, you can look at the IRS 20 Factor Assessment starting on page five. If even just a couple of these are accurate, you have an employee and not a subcontractor. This will help make sure you are protected as much as possible from potential liability exposures. Although it can be a hard decision sometimes, and saving money often seems like the best route to go in, I urge you to consider the realistic possibility of a large claim. This scenario is much more costly than the workers’ compensation policy. Please do not believe the myth that if you pay employees on a 1099 format you are safe from consequences. You may bypass the state requirements, but that does not exempt you or the organization from being held liable.

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