Many companies try to avoid the time and expenses involved in withholding payroll taxes and paying the employer match by hiring their workers as 1099 independent contractors. I have seen this strategy attempted many times and, although it can be an attractive idea, it can also be a huge trap.
If you pursue this strategy, you must do so very deliberately because it can backfire and, despite your honest intentions, if the IRS determines that your 1099 contractors are actually employees, you can be responsible retroactively for taxes, penalties and interest. The IRS has what is sometimes called “the list,” which lays out the twenty-seven questions or qualifications that each and every worker must meet to qualify as an independent contractor.
Let’s say your 1099 independent contractor qualifies except that he or she wears a name tag that he or she bought with your company name on it.
In this case, the IRS can determine that your independent contractor is an employee and hit you for the taxes, penalties and interest, and so too can the state for liabilities such as unemployment compensation. In fact, this scenario played out with an MP Star Financial client and it put them out of business.
So if want to pursue the 1099 independent contractor route, you should consult the Employer’s Supplemental Tax Guide and retain a labor attorney to make sure it is done right.
You can also find additional info about hiring people as 1099 independent contractors here.