What Is a 1099 Employee? Classification, Pros/Cons, Taxes & Payments

Freelancers, gig workers, consultants and independent contractors are all considered 1099 employees although they are not employees at all. Their accurate term is actually self-employed workers or non-payroll workers.

Unlike employees, self-employed workers are responsible for reporting their own income and paying their own self-employment taxes, which cover Social Security and Medicare. They are not defined as employees legally, therefore the term 1099 employees is quite problematic.

Below is a breakdown of 1099 ’employees’ who fill out a 1099 tax form, and what you need to know if you’re considering hiring them.

This is part of an extensive series of guides about compliance management.

What Qualifies as a 1099 Employee?

Simply put, a 1099 employee is a non-payroll worker. They might be self-employed or they may own a business, but they are not employees of your business. Usually, if you offer a worker a long-term contract, an open-ended role with your company, and they have a job description that they need to keep to, they are not a 1099 employee.

On the other hand, if they have a short-term role or project to do with your business, and they have control over how they complete that work, they are likely to be a 1099 employee.

1099 Employee vs W-2 Employee: What Is the Difference?

A W-2 employee is a worker who is on a company’s payroll. The term “W-2” comes from the IRS form that employers must file annually to report wages, tips, and other compensation paid to an employee. Employers withhold income taxes, Social Security, and Medicare from the employee’s wages and contribute a matching amount for Social Security and Medicare.

W-2 employees typically receive benefits such as health insurance, retirement plans, paid time off, and other employee perks. Employers have significant control over how, when, and where W-2 employees perform their work. These employees often have set hours, follow company policies, and use company-provided equipment. W-2 employees usually have a more stable employment relationship, often with ongoing roles and the potential for long-term career development within the company.

1099 employees do not have taxes withheld from their paychecks. They are responsible for paying their own income taxes and self-employment taxes, which cover Social Security and Medicare. This requires them to file estimated tax payments quarterly. 1099 employees do not receive traditional employment benefits such as health insurance, retirement plans, or paid leave. They must arrange and pay for these benefits independently.

Independent contractors have greater control over how they complete their work. They set their own hours, choose their work methods, and often use their own tools and resources. They are hired to complete specific projects or tasks and are not subject to the same level of supervision as W-2 employees. The employment relationship is typically less stable and project-based.

Related content: Read our guide to difference between w2 and 1099

How to Classify a 1099 Employee

A worker is considered self-employed if the paying company cannot control or direct how the work is done. To help employers make this determination, the IRS offers three “common law rules” to consider:

Behavioral: Does the paying company control or have the right to control what the worker does, as well as how the worker does their job?
Financial: Does the paying company control the business aspects of the worker’s job, such as how the worker is paid, whether their expenses are reimbursed, or who provides equipment/supplies?
Type of relationship: Is there a written contract? Does the worker receive employee-like benefits from the company, such as a pension plan, insurance, or paid time off? Is the relationship on-going, and is the work performed a key aspect of the business?

Businesses must review all of these questions when classifying a worker as a 1099 employee or a W-2 employee. Often, the answer isn’t black or white — some factors may indicate a worker is self-employed while others may suggest the relationship is employee-employer.

According to the IRS, “The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.”

1099 Employee Rights

What rights does a 1099 employee have? As they are not actually an employee at all, self-employed or 1099 workers do not have the rights that we tend to think of when we consider employees, such as sick pay, overtime, parental leave, or pension plans.

Instead, 1099 employees have the right to act unlike a regular on payroll employee. They have the right to work in the location of their choice, the right to set their terms for payment, and the right to work during the hours that are agreeable to them.

If you don’t set out specific terms in your freelancer contract, you might find that the way that your 1099 employees work isn’t a good fit for you. For example, they could terminate the agreement without notice, consider themselves to own the output of their work, or be unavailable for meetings or team get togethers.

1099 Employee Benefits

While traditional employee benefits aren’t a factor for 1099 employees, there are many benefits to being your own boss. Independent contractors have the freedom to say yes or no to specific projects or clients, take time off as and when they choose, and set their own prices – raising them at their own prerogative.

It can be helpful to offer your 1099 workers certain benefits to make sure that you’re their preferred client! This could be learning and development opportunities – such as inviting them to courses or to hear visiting speakers, or it could be holiday bonuses, or inclusion in corporate away days.

While employee benefits like vacation days and retirement funds need to be factored into their ongoing costs, for many – the autonomy and freedom of being a 1099 employee is all the benefit that they need.

How Do 1099 Employees Get Paid?

1099 employees typically get paid per project or task, rather than receiving a steady salary like W-2 employees. The payment terms and schedules are usually outlined in the contract between the independent contractor and the hiring company. These contracts specify the scope of work, the payment amount, and the schedule or milestones for payments.

Invoicing

A common payment method for 1099 employees is through invoicing. After completing a project, or a portion of it, the contractor sends an invoice to the hiring company. This invoice details the services provided, the hours worked (if billed hourly), and the total amount due. The contractor might also include expenses incurred during the project for reimbursement.

Payment Terms

The payment terms can vary widely. Some common arrangements include:

Upon completion: The contractor receives payment once the entire project is completed and delivered.
Milestone payments: Payments are made at predetermined stages of the project. This helps manage cash flow for both the contractor and the hiring company, ensuring that work progresses as agreed.
Retainers: For ongoing work or long-term projects, a contractor might receive a regular retainer fee, which is a fixed amount paid periodically (e.g., monthly). This fee secures their availability and services for a set period.
Hourly rates: Some 1099 employees charge by the hour. They may submit timesheets or detailed logs of hours worked along with their invoices.

Payment Methods

Methods of payment can include direct deposit, checks, electronic funds transfers (EFT), or payment platforms such as PayPal or Venmo. Direct deposit and EFT are often preferred for their speed and security.

Tax Responsibilities

Unlike W-2 employees, 1099 employees receive their full pay without any tax withholdings. This means they are responsible for setting aside a portion of their income to cover self-employment taxes, which include Social Security and Medicare contributions. To avoid penalties and interest, 1099 workers must file quarterly estimated tax payments to the IRS.

Record Keeping

Accurate record-keeping is crucial for 1099 employees. They need to maintain detailed records of their income and expenses to correctly report their earnings and claim deductions on their tax returns. This includes keeping copies of all invoices, payment receipts, and records of any business-related expenses.

Contractual Clauses

Contracts between 1099 employees and hiring organizations often include clauses related to payment terms, such as:

Late payment fees: Penalties imposed on the hiring company if payments are not made on time.
Advance payments: A portion of the total payment made upfront before the work begins. This can help cover initial costs for the contractor.
Expense reimbursement: Terms specifying which expenses (e.g., travel, materials) will be reimbursed by the hiring company and the documentation required for reimbursement.

The 3 Advantages of Hiring 1099 Employees

Here are the three main advantages of working with 1099 employees over W-2 employees.

#1 Lower business expenses

Unlike regular W-2 employees, paying companies are not required to pay taxes on behalf of self-employed workers, contribute to workers’ comp or unemployment insurance on their behalf, or provide health benefits. Companies are not subject to a minimum wage limit or overtime regulation, nor do they need to provide sick days or retirement benefits.
At the end of the day, businesses can save as much as 30% on human capital and associated costs by enlisting freelancers or other types of self-employed workers, according to Business Law Today.

#2 Access to elite talent

Best-in-class workers increasingly opt to work for themselves in order to enjoy the benefits of a flexible work schedule, freedom to set their own rates, and the ability to pick and choose which customers to take on.
Businesses that work with 1099 employees will gain access to this highly desirable pool of talent, which enables them to produce better outcomes.

#3 Greater market agility

With a smaller permanent workforce, businesses are leaner and more agile in the face of unexpected changes or sudden loss of budget. It’s much easier to end a working relationship with a self-employed worker than a full-time employee. On the more positive side of this point, it’s also much faster to dive into work with new freelancers for project-based work than it is to interview, hire, and onboard new employees.

Disadvantages of 1099 Employees

Here are the three main disadvantages of working with 1099 employees.

Limited Control

Companies have limited control over these workers’ processes and schedules. Since they operate independently, companies cannot dictate how, when, or where they complete their tasks. This independence can lead to inconsistencies in work quality and challenges in ensuring that the deliverables meet the company’s standards and expectations.

Difficulty Finding Top Talent

High-quality freelancers often have the flexibility to choose their clients and projects, making them more selective about whom they work with. This means that recruits may need to compete with other companies to attract the best independent contractors, offering higher pay rates, favorable contract terms, and additional incentives.

Temporary Workforce

Independent contractors are typically engaged for specific projects or short-term assignments, and once the work is completed, the contractual relationship often ends. This transience may require companies to repeatedly invest time and resources in finding, hiring, and onboarding new contractors for each new project.

What Are a 1099 Employee’s Rules?

Your 1099 employees need to take responsibility for filing and paying their own self-employment and income taxes. The self-employment taxes pay for social security and Medicaid, while income taxes are based on how much they have earned in a given tax year. Your business is not responsible for withholding taxes from a 1099 employee’s earnings.

For the business, the rules are pretty simple. You report the earnings of your independent contractor using form 1099-MISC if you have paid them $600 or more during that tax year. If you misclassify an employee as a 1099 worker in order to reduce your tax burden, you could face hefty fines and serious business penalties.

Related content: Read our guide to 1099 rules for employers

Can You Collect Unemployment If You Are a 1099 Employee?

The system for unemployment payments in the U.S. is funded by Federal Unemployment Tax Act (FUTA) taxes and State Unemployment Tax Act (SUTA) taxes. As a business does not pay state and federal unemployment taxes for a non-payroll employee, an independent contractor cannot collect unemployment. This means freelancers do not qualify for unemployment.
However, in certain situations there may be funds available for 1099 employees who are out of work. For example, during the COVID-19 pandemic, the government made funds available for small businesses, including many 1099 workers, who were out of pocket due to the virus.

What Are the Different Categories of 1099 Employees?

As self-employment rises in popularity, a variety of definitions have emerged to distinguish the different natures of work. All of the following titles can be considered 1099 employees.

Freelancer — An individual who earns money by the job, task, or hour, usually for short-term work. Freelancers often work with multiple clients simultaneously, unless contracted to work exclusively for one company.
Gig worker — Someone who performs temporary, flexible jobs, often through an online app or platform. Uber, Lyft, Instacart, and other driver-based companies operate on gig worker labor.
Crowd workers — Also known as crowdsourcing or platform work, crowd work refers to the outsourcing of tasks to a large pool of online workers via an online platform, rather than to a single worker or employee.
Outsource teams — Third-party or external teams that are not part of your organization may be enlisted to perform tasks, handle operations, or provide services to a paying company.

Who Needs to File a 1099 Tax Form?

Any self-employed individual who earns a total of $400 or more from all of their clients in one year is required to report their income to the IRS and pay taxes on it. The IRS considers a worker to be self-employed if they meet any of the following criteria:

They perform a trade or business as a sole proprietor or an independent contractor
They are a member of a partnership that carries on a trade or business
They are otherwise in business for themselves, including part-time work

The Risks of Working with Self-Employed Workers

The IRS is not fond of companies that inaccurately classify their workers, especially if they suspect the company may deliberately be doing so to evade taxes. Because this does happen, there are strict penalties in place for companies that misclassify W-2 workers as 1099 employees.

If your company misclassified workers, even by accident, you could face multiple penalties, fines, back-taxes, and even lawsuits filed against you by the workers themselves. That’s why it’s important to reassess the nature of your relationship to your 1099 workers every six to 12 months to ensure you are in compliance.

Many states have recently become more attuned to the issue of worker misclassification, as well as the implications for self-employed folks who don’t have access to typical employee benefits and protections. That’s what led California to pass the contested Assembly Bill 5 in 2020, and subsequently, Proposition 22.

Should You Work with 1099 Employees?

By now, you may be asking yourself this question. However, instead of asking if you should work with 1099 employees, you should ask how to do so without creating risk.

In the current business climate, it is difficult for businesses to be agile, fast, and competitive without 1099 employees. Relying exclusively on full-time employees hinders speed and costs more.

In the new reality, businesses are increasingly working with self-employed workers to do a wide range of work. According to Upwork’s Future Workforce Report:

73% of hiring managers plan to continue working with or hire more freelancers
59% of hiring managers believe that companies that don’t develop a “flexible workforce” are falling behind

Working with independent contractors is a great choice because it provides access to a highly desired pool of talent and allows you to lower overhead costs. And, if you find high-performing workers, you can rely on them to deliver the best results.

As long as you perform your due diligence and don’t try to cut any corners with the IRS, working with 1099 employees is a major advantage.

To learn more about how Fiverr Enterprise can help automate and customize the legal and tax compliance process for your freelancers, book a 30-min demo with one of our workforce experts today!

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What Is a 1099 Employee? Classification, Pros/Cons, Taxes & Payments