If you have contractors working with you on a regular basis you need to make sure they are classified correctly.
Today’s workforce is becoming more diverse. As a company the chances are you regularly work with all sorts of different professionals including part-time and full-time employees, contractors, and freelancers. As working relationships evolve, you’ll need to satisfy the regulators that everyone is classified correctly. That means getting to grips with something called 1099 employees.
What is a 1099 employee?
So, how does a 1099 work? The term is slightly misleading as they are not employees in the strict sense. A 1099 worker is likely to be a freelancer who has developed a relatively close working relationship with your company.
They may be working on a contract-to-contract basis and will often be seen in your office working directly with your team. In a more diverse workforce, they can often look and feel much like any other regular employer. However, they are treated very differently for tax purposes.
The key thing to understand is the difference between someone who is a freelancer and a full-time employee. A 1099 worker will fall somewhere in the middle.
According to the Fair Labor Standard Act, (FLSA) you should think about three factors to qualify them.
Behavioral patterns
To stay classified as a 1099 employee a professional must control who and when they work. Employees will generally have to abide by a set of practices such as working time, location, and deadlines. With an employee, you can demand work be done by a certain time. With an individual contractor, you have to account for their schedule. They should have the freedom to choose where they work and the pattern.
This could include working in your own office which could make them look and feel just like another part of the team. The important thing is that they should have a choice in where they work.
With an employee, you may choose to offer flexibility of choice, but in the end, you will have the right to demand certain parameters if you wish.
Financial conditions
A regular employee is offered a set salary. However independent contractors, and 1099 ‘employees’ set their rates by negotiation. These rates could be hourly or on a per-project basis. The difference is that when you engage a contractor, they will tell you their rates and
you can either agree to meet them, haggle, or work with someone else.
It’s a more fluid and dynamic working relationship in which workloads and payment may vary considerably from one month to another.
Crucially, your employees will not bear any financial obligations or expenses when working for you. As an employer, you will regularly reimburse people or expenses they incur on the job and pay for all their equipment.
Contractors pay their way and will attempt to offset all expenses against tax. This will be a matter for them to decide independently with the tax authorities. It’s a more flexible arrangement for both sides. You don’t have to bear additional expenses, and they can set their own working time and patterns.
Working relationships
Employees have a regular and ongoing working relationship as defined in their employment contracts in which they can expect to receive a regular wage for the duration of their employment.
Contractors should work on a purely contractual basis in which work is delivered and the contract ends. Neither side needs to continue the working relationship beyond that. If you want to continue working with them at the end of a project you will need to draw up another contract in which the terms of deliverables and payment are drawn up.
These are often referred to as the common law rules and they will be used by tax authorities when looking at a working relationship.
The benefits of 1099 workers
Companies will hire a 1099 worker for many reasons. It is generally cheaper and much more flexible. You will not have to pay any employer-related taxes or regular expenses. They will handle all their tax details.
It’s also much more flexible. You can work with them on a case-by-case basis which means you’re only paying them as and when you need them. It helps you scale up or down your workloads as and when you need it.
1099 workers will also have more freedom. They can set their working patterns and will be free to do work for other companies. They will not be tied to a specific company and have complete control over when they work or how they work. The downside for them is that they do not have the same level of security that an employee has and may see their payments rise and fall from one month to another.
From an employer’s perspective, the downside of 1099 workers is that you don’t have as much control over their output. Commitments are by definition short term and you may also find it difficult to integrate them with the rest of your team.
The biggest thing to watch out for, though, is the legal risk of misclassifying a 1099 worker.
Misclassifying working relationships
Getting the working relationship right is important. Authorities are keen to crack down on practices of disguised employment in which companies try to enjoy all the benefits of independent contractors – namely cost and flexibility – while using them as defacto employees.
In other words, if they see no difference in the working conditions of a contractor – such as someone who earns a set retainer every month regardless of separate contracts, and has to remain in the office, they may determine that person to be a defacto employee.
If that happens, they may impose hefty fines and require your company to make up the differences in wages and missed benefits. If they decide that the breach was deliberate you may even find yourself in line for criminal charges.
Working in overseas countries
For foreign companies outsourcing to countries such as South Africa, accidental misclassification of workers is a considerable risk. Employment laws can be complex, and strict and are constantly changing. Without a full understanding of the law or a presence in the country, it can be difficult to make sure you continue to be compliant.
This can be particularly difficult given the fact that workforces are becoming more complicated. If you’re in the process of moving operations overseas or expanding into a new territory you may have many different types of working relationships and contracts.
Some people may be employed directly. Others may be one-off freelancers and some may be semi-regular contractors with an ongoing case-by-case relationship. As you move more closely into the country it’s those contractual relationships that you need to keep an eye on. If you’re not careful the line between a 1099 worker and a full time employee can all too easily become blurred.
To avoid compliance issues it’s a good idea to work with a specialist outsourcing company. An Employer of Record (EOR), Agent of Record (AOR), or Professional Employer’s Organization (PEO) can provide local specialist knowledge to help you classify employees correctly.
An EOR serves as the legal employer for your workers in a certain country. They handle details such as PAYE, onboarding, and classification and also have legal responsibility for compliance with the rules. That means if there is a 1099 issue it is the EOR who will be held responsible.
A PEO offers a similar but slightly different approach. They will share employment with them taking on the role of an HR department and managing the administrative details and legal requirements of employment. They will also offer dedicated local knowledge and legal insights.
An AOR, meanwhile, is aimed at contractors. They will be able to support the classification of contractors and freelancers as their relationship builds. Their role will be to keep you out of trouble when you get into the 1099 grey zone between employment and freelance contracts.
At Future Teams, we can provide full support and EOR services to help you manage your working relationships with South African-based employees. We can help you avoid compliance issues and stay on the right side of the regulator.
