Playing by the Law: 1099s vs. Employees

by Chris Arlen on January 7, 2011

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The beginning of 2011 finds me a little more ornery than normal. May be old age, or an unusually cold winter. Either way here’s a touchy topic and an ornery response.

Suppliers hiring employees as 1099s

I’ve heard an increasing number of service suppliers complain about the black hats in their industry who hire workers as independent contractors (1099s) when they’re really employees. As 1099s, the supplier avoids lots of costs, such as insurances, payroll taxes, overtime pay, and other costs that true 1099s are responsible for on their own. That is if the workers were truly 1099s. That’s the swap black hat suppliers make; employees for 1099s.

As a result, black hat pricing can be significantly lower than suppliers with employees – providing the dark side unfair pricing advantages for new business.

The improper (read illegal) use of 1099 workers instead of employees has likely increased during the Great Recession. Black hats may have become more opportunistic seeing more price sensitive customers out there. Customers may have become more blind towards suppliers’ practices now their survival is on the line.

Most of the instances I’ve heard of suppliers illegally using 1099s are in the janitorial industry. The practice gets even cloudier when a contractor subcontracts a portion of their work and their subcontractor has switched their employees to 1099s. How much responsibility does a prime contractor have for checking on their subcontractors’ hiring practices?

Mistaking employees for 1099s?

IMHO (In My Honest Opinion) there’s no reason to confuse the proper employment status of an employee for a 1099.

The IRS doesn’t think so either. Check out their  Employee vs. Independent Contractor – Seven Tips for Business Owners. If you want them to check for you who’s an employee and who’s an independent contractor they will, you betcha.

Who suffers anyway?

More than many of us might believe. Try: the industry’s reputation, market pricing, white hat suppliers, workers and customers.

Poor industry reputation lowers service to commodity level

When a black hat explodes the fallout taints that service industry, sometimes even harming outsourcing in general. Remember Walmart and the undocumented worker scandal (Feds: Wal-Mart Knew About Illegals)?

Bad PR for an industry has the effect of lowering it in the eyes of customers and their buyers. And when buyers have a lower opinion of an industry, it’s easier for them to commoditize it. Once that’s done, squeezing costs out of a commodity is easier than gaining the best value from a strategic service.

Market pricing

Black hat pricing is artificially low. It deludes customers into thinking they’re paying the appropriate price – and that incorrect price now becomes established as the low water mark for service.

Hard to correctly price service relative to that lowball. Legitimate suppliers’ pricing can now appear inordinately high. Customers may wrongly think “what’s going on here, are these suppliers trying to gouge me?”

White hat suppliers

When a customer has their service disrupted because a black hat supplier is caught, the word goes out among that customer’s peers. That broad brush catches all suppliers and makes them look less than trustworthy, regardless of their innocence.

Workers

Service workers work hard. If you’ve cleaned thousands of square feet per hour, night after night, month after month, for years you’ll know. When hired as 1099s, workers don’t get overtime, are responsible for their own insurances and paying taxes (and other business tasks as well). They’re locked out of the protections we take for granted as employees.

Customers

Bad PR also splashes onto the customer who hired the black hat suppliers (again, the Walmart experience).

What can the good guys do about the black hats?

As promised, here’s the ornery response. If you’re one of the good guys (worker or supplier or customer) tell the IRS about the black hats.

Yup, point the finger. The IRS finger that is.

You can do it anonymously, using IRS form 3949A. You don’t need to identify yourself. The exact language on the IRS form says:

“6. Enter your name, street address, city, state, zip code and a telephone number where you can be contacted. Indicate time of day you may be contacted if appropriate. This Information is not Required to Process Your Report.

The IRS form highlights that last sentence in bold and in a larger font. They really want you to know they’d rather hear from you, than not.

In the end

I don’t think there are large numbers of black hat suppliers, but there are a few. The lawful consequences may help (may) level the playing field for the good guy suppliers, and in turn better protect workers, customers, and the reputation of outsourced facility services.

Good luck in selling and serving with a clear concience.

~~~~~~~~~~~~~~~~~~
Chris Arlen
President
Revenue-IQ

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{ 7 comments… read them below or add one }

Steph February 3, 2013 at 7:10 pm

I was hired as an independent contractor last March. It was never really explained to me what that meant or why taxes weren’t being taken out of my taxes. I just got my 1099 and I’m starting to grasp the reality of paying 2-3,000 dollars in taxes. I work about 40 hours a week at a desk in an office on a company provided computer doing tasks that they assign me. I suspect that they cut corners by hiring me (and some of my other co-workers) as an independent contractor and I’m trying to figure out something to do about it.

Any help? I’m young (only 23) and I feel like I got scammed because I didn’t know better. This tax season is going to set my student loan payments back by a few years and that is a huge loss to take.

I’m very panicky. Thanks for reading.

Steph February 3, 2013 at 7:11 pm

*taxes weren’t being taken out of my paychecks

Chris Arlen February 4, 2013 at 6:43 am

1099 status is only beneficial for the employed if they look at their work as a business, i.e. with multiple clients, and/or high enough revenues to live on and then extra to cover their tax liabilities. Obviously this only works if one knows they’re being paid as a 1099 and what that means.

There’s always IRS form 3949A to report an employer suspected of abusing 1099 status.

Unfortunately, that’s not going to help you with your taxes, and you’re going to be liable for them. It’s sad to hear of anyone being surprised by an unexpected tax bill but it does happen. Good luck.

Ian September 9, 2013 at 3:23 pm

I believe there’s a lot more of this going on these days. I under-reported income in years past that was on a 1099, at the end of the day I operated my “business” at a loss and effectively worked a couple of weeks for free. What this means is that certain “employers” take advantage of people who don’t understand tax laws in the US – as is stated above. If you don’t understand what a 1099 is, walk away. You’re likely not a business owner and someone is likely trying to avoid paying employee and payroll taxes. In my circumstance I don’t believe the business in question was doing anything wrong or illegal, however it certainly didn’t make sense for someone in my position (read: low income) to leave my 9 to 5 for a week or two at a time to make some “quick cash” – while great for cash flow you have to understand your tax responsibilities as a business owner, because that’s how the IRS will treat you if they see income filed under a 1099. Makes you appreciate all your time under W2 employee status! I now focus on my main means of employment and appreciate the steady flow of income versus larger lump sums that were never enough to justify owning my “business” – I wish more young people could learn from our mistakes!

John burns January 2, 2014 at 12:57 pm

I have been working as a 1099 sales rep for the last 5 years. the company has never asked me to provide proof of workman’s compensation insurance incorporation or anything else along that line. I believe they have me as 1099 illegally to save money for the company. how can I determine if I am an illegal contractor?

Chris Arlen January 2, 2014 at 1:39 pm

John,

First, check the IRS’ definition of employee vs 1099. Theirs’ is the only definition that counts.

Then, if you believe you should be an employee rather than a 1099, report your firm anonymously to the IRS on form 3949A.

Good luck.
Chris

Jeff January 16, 2014 at 4:34 pm

I’m in the same exact boat as Steph.

I’m also young (25) and right now I’m working as a 1099 behind a computer (content project tracker) at a shoe company in LA. I looked at the website you recommended, but the areas are so grey that I don’t really know if my position is illegal or not. For example, the “how i complete my job” is not micromanaged, but it’s a pretty straightforward job, very entry-level. Also, I didn’t go through any training for this position. though wouldn’t the company be saving $$$ by not sending me through training?

I receive no insurance, have no personal workers comp ( I had to sign a safety waiver when I was hired), and have not paid any taxes on this position, although I am starting to get worried.

Are there any other places I can learn about my rights or whether this position I’m in is legal? Before this, I had a bunch of unpaid internships; i feel like I keep getting screwed over.

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