Beware of the 1099 trap when bringing on help!

Beware of the 1099 trap when bringing on help!

Payroll taxes, withholding, overtime pay, workers compensation and benefits – even headaches over managing hiring and firing - these are all large expenses and complexity that hold business owners back from bringing on employees. Some employers try to avoid the complexity and cost by labeling the worker as a subcontractor and paying them “on a 1099”. In some businesses, that can work, however you need to be very careful about mislabeling an employee as a contractor.

1099 payments go to independent subcontractors. The word “independent” is very important. A person that performs work under your direction for a fee is an employee. A person that performs work without direction for a fee is a contractor.

The IRS has definitions and requirement from tax and employment rules that are best discussed with your accountant. If the business is audited and found to be incorrectly labeling employees, large fines and taxes can be levied and the longer it goes on, the more painful that can become. There is a chance it can become a criminal case if it was done willfully to avoid paying taxes. Take a quick look at the IRS page on Independent Contractors:

And consider how even large companies like Fedex had to deal with this case of mislabeling contractors:

From an insurance perspective, there are several traps that using subcontractors as employees can create which limit your choices and double your costs (at least!)

In Georgia, every worker that cannot be excluded from the statute must have Workers Compensation premium paid for them at some point in the contract chain. What that means is that if you hire a subcontractor that does not have workers compensation insurance, you will cover the fees paid to them with your workers compensation insurance policy. This is usually determined at audit time and most times results in a very large, unanticipated bill.

Insurance companies do not like to provide workers compensation policies for businesses that use a lot of uninsured subcontractors. Why? By definition, independent subcontractors are independent. Meaning the management of the company does not control policies and safety utilized by the contractor. Things like safety equipment and supervision are all supposed to be supplied by the contractor themselves. In order for the policy holder to keep control of safety procedures and keep claims to a minimum, these companies want to see less subcontractors and more employees and will decline to write policies for many companies that use subcontractors.

It cannot be both ways. You either control the safety environment of the employee, or you don’t, and if you don’t, contractors should provide workers compensation. If you utilize a lot of subcontractors, many times you will not have much choice except for the assigned risk pool. This will often increase your insurance costs 2 to 3 times standard market rates. This makes profitability and budgeting very difficult, however there are a couple of steps that can help you do things properly and leverage the most from your employees.

  1. Have a discussion with your accountant about the employee plan, the work requirements you need and the costs involved in putting people on the payroll.
  2.  Implement Employee Handbooks, Procedures and Payroll processes. Services are available to help you do this simply and rapidly for little to no cost.
  3.  Discuss the insurance requirements for your business with your insurance agent to see the costs involved with hiring employees. Some businesses require minimum levels of payroll, or minimum premiums.

The last thing you want to do is find out that the cost for workers compensation insurance is 3 or 4 times what you imagined and find that out after receiving a bill. There is nothing worse than realizing that all of the profits for a job end up paying insurance premiums!

Our agency provides clients with tools to help build solid HR processes for small businesses and we can directly help with payroll and workers compensation. We would be glad to evaluate your challenge and provide advice on the changes required.


Ken Wilcox