When talking business, an employee and an independent/subcontractor are not synonyms and they should not be used interchangeably. These two classifications come with some very important distinctions in how that worker is paid, how much control you have over them, how they represent you and your business, and how much they cost you.

Per the IRS: You generally are not an employee unless you are subject to the will and control of the person who employs you as to what you are to do and how you are to do it. 

As an example, if I pay you a flat fee, every other week to show up to our company BBQ on Friday afternoon to sell some ice cream out of your truck, you're just a subcontractor to me. I don't tell you how to scoop the ice cream, you have your own costs and whether you make money on the event is up to you, not me, so even though you're working for me, you're not my employee.

However, it's rarely ever cut and dry, especially in tax and employment law, so the IRS uses the Common Law Test to outline three categories to consider when determining if a worker is an employee or a contractor. Those categories are Behavioral Control, Financial Control, and Relationship of the Parties. It's important to keep in mind that no one factor stands alone in the classification determination. You need to consider all three categories when deciding if the worker is an employee or contractor.

Behavioral Control:  A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised.

Financial Control: Does the business have a right to direct or control the financial and business aspects of the worker's job? Who is paying for the worker's expenses? If you're paying only for the worker to provide a service, and it's up to them whether or not their costs are covered by your fee, they're probably a subcontractor.

Relationship: The type of relationship depends upon how the worker and business perceive their interaction with one another. This includes written contracts, benefits, permanency of the agreement and types of services they're providing the business. This includes whether or not they're representing your company in public, if they have an email address with your company, etc.

We'll talk more about examples that the IRS gives to help you determine if your worker is a contractor or an employee in the Advanced Business Information course.

So now what?

If you're comfortable after reading the categories above that you have a subcontractor working for you, and not an employee, then there are just a few steps you need to make sure you take.

For year-end 1099 purposes, collect a W-9 form from them before they do any work for you and before you pay them. The W-9 will ensure that you know who you're paying and who they want the payment made out to. It also allows you to have all of the information you'll need at year-end to issue them a 1099-NEC, which tells the government how much you paid that contractor. Issuing the 1099-NEC allows your business to deduct that payment as a business expense, and it means that your contractor will have to pay tax on that income because the IRS knows about it.

The last thing to check is your state's employment laws regarding worker's compensation coverage. Most states require independent contractors to provide their own worker's compensation coverage, so make sure if this is the case for your state, that you check that their coverage is up to date.

What to expect at Year-End?

Once the year is over, you'll total up all payments made to each subcontractor in a given year, and issue them a 1099-NEC for the total amount you paid them (over $600). A copy of that 1099-NEC will be sent to the IRS, and also to the contractor. That's all you need to do.

What happens if I just pay everyone as a 1099 worker/subcontractor?

Classifying an employee as an independent contractor with no reasonable basis for doing so makes employers liable for employment taxes. This means that if anyone finds out that you're doing this, your insurance company, state, or federal government, you'll be on the hook for the entire social security and medicare tax amounts owed on the amount you paid your subcontractors. That's 15.3%, on every subcontractor payment you made.