1099 Employee Benefits

by Adarsh Raj Bhatt in
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Key Takeaways

  • Independent contractors are often referred to as 1099 employees, named after the tax form (Form 1099) that their employers are expected to fill out to report their independent contractors' earnings to the IRS.
  • Independent contractors, contract employees, self-employed individuals, and sole proprietors are all terms used to describe 1099 employees.
  • 1099 employees have a great deal of influence over how they operate, while their customers have relatively little.
  • 1099 employees are not entitled to any of the standard benefits, such as an office space, paid vacation leave, or employees' compensation.
  • The most significant advantage of working as a 1099 employee is the freedom to choose who you work with and under what conditions.

Who is a 1099 Employee?

In view of the current pandemic, startups are going virtual and recruiting contractors across international borders. 

But the question is: 

Who is a 1099 Employee? 

A 1099 employee is someone who isn't classified as a regular employee under the law. Independent contractors are classified as 1099 employees. This means that instead of hiring a permanent (or at least a long-term) employee who works under the guidance of the startup, the startup hires an independent contractor who is self-directed.

The distinction between a 1099 employee and others is generally obvious. For example, a painter hired to paint your home is an example of an independent contractor. After the job is completed, they would no longer be your employee.

The 1099 label (or distinction) is inaccurate if you require a permanent employee. A conventional employee is someone who (at least, in the pre-COVID, pre-lockdown world) must: 

  • Report to work
  • Adhere to a workplace dress code
  • Always report to their boss

Bottom line?

Employees with a 1099 status are self-employed independent contractors. They are paid according to the terms and conditions stated in the contract and receive a 1099 form on which to report their income on their tax return.

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How does a 1099 employment work?

The Department of Labor has introduced new guidelines for deciding whether someone is an independent contractor or a regular employee. While the ruling was supposed to take effect in March 2021, the Biden administration has put a hold on all regulations until they can be checked. 

Why does this matter?

When approved, the new ruling would clarify the norm, bringing more consistency to the new gig economy by creating a series of tests:

The basis of these tests is an "economic reality check" to see whether the person is operating their startup independently or if they're financially dependent on the startup.

Two important factors in determining the economic reality test are:

  • The extent and degree of influence someone has over their own jobs
  • The employee's potential for benefit or loss

If the two core factors vary, use the following other factors in the analysis:

  • The level of expertise needed for the job
  • The employee-employer relationship's long-term viability
  • Whether or not the work is an element of the final product

The IRS demands that employees be properly categorized as independent consultants or employees, for a multitude of reasons (mostly payroll taxes). Unless you can show otherwise, the IRS recognizes the person in question as an employee.

Offer letter for 1099 employees

By using a standard agreement, startups could speed up the recruiting process for independent contractors. Utilizing an independent contractor agreement template ensures that everyone involved in the recruiting process at your startup uses a clear-cut and legally sound document.

If you employ an independent contractor, make them sign an independent contractor agreement so that everyone understands their obligations as well as conditions of employment. The stipulations might differ significantly from one contractor to the next -- or even from one startup to the next.

For instance, certain provisions (like an agreed-upon amount of pay in lieu of insurance and holiday pay, as well as basic expenditures including travel and meals) might be included in some contractor agreements and not in others.

Consider hiring an attorney to review or redesign your independent contractor agreement, particularly if restrictive covenants are included. If you use a sample, such as the one available for download below, double-check it to make sure that no modifications are necessary. 

Here is an example of an independent contractor arrangement sample. It's created to be downloaded and used by entrepreneurs.

Source

Here are some more 1099 offer letter templates and contract employee offer letter samples.

Can a 1099 employee participate in a 401k plan?

A contract employee 401(k) is a one-participant 401(k). It's especially appealing to people who want to save a lot of money for retirement or freelancers who want to invest more money in 401k while they’re in the prime of their career. You won't need to establish an LLC or a corporation, and your spouse can take part as well if you recruit them.

Since you're self-employed, these policies allow you to contribute $19,500 as an employee and 25 percent of your net income as an employer contribution. The maximum employee contribution for those aged 50 and over is $26,000. The amount of employee and employer contributions do not exceed $57,000.

Contribution caps would apply to both your and your spouse's 401(k) plans if you or your spouse have a 401(k) from another startup. One-participant 401(k)s are available from several mutual fund and investment firms. The IRS will need an Employee Identification Number - which is free and only takes a few minutes to obtain online

But there’s a catch.

You would not be eligible for this form of account if you have employees other than your spouse.

You might also choose a Roth 401(k) that works similarly to a Roth IRA. You'll make post-tax investments, so withdrawals would be tax-free. If you hope to earn much more in retirement than you do now, these plans are ideal. They allow you to stop paying a higher rate of tax after you retire.

How does a 1099 employee pay taxes?

For tax purposes, the bulk of sharing economy jobs are 1099 contractors. 

If you create a corporation for your startup, you could avoid being classified as a 1099 contractor. The IRS considers 1099 employees to be self-employed and taxes them accordingly. So, you must pay self-employment tax if your earnings exceed $400.

Self-employment taxes, which would include Medicare and Social Security, are about 15.3 percent. The amount you can save for income tax is determined by your tax band. For example, if you make $15,000 as a 1099 contractor and file as a single, non-married person, you can plan for 30-35 percent of your income to be set aside for taxes. 

We can’t emphasize this enough:

For contract employees, self-employment taxes are calculated on net income rather than gross income. As a result, you'll need to remove deductions from your gross income to arrive at your net profits.

1099 vs w2: Which is better for employees?

Pros of 1099 vs W-2 Employees

Specific Expertise

For unique or specific assignments, many employers need individuals with specialized skills. 

An external management consultant, for instance, is an independent contractor since he or she is employed to address a particular issue. Some contractors can charge exorbitant hourly rates and contract fees due to their high expertise. The contractor profits because he or she will typically earn more by working less.

Less Expensive

1099 employees are not eligible for insurance or reimbursements despite receiving high hourly rates or project fees. 

Employers can save money by not having to pay for holidays or costly healthcare coverage. Employers are not required to pay FICA or unemployment taxes (FUTA and SUTA) on contractors.

More Freedom

Both the contractor and the startup or employer will profit from this. 

High-earning freelancers will earn more while working less and have a stronger work-life balance. Employers would not be required to provide overtime pay or workers' compensation to their 1099 employees. 

Pros of W-2 over 1099 for Employees 

Employee Benefits

W-2 employees are eligible for benefits such as: 

  • Paid training
  • Health insurance (usually available for full-time employees) 
  • Sick/vacation compensation 
  • Expense reimbursement

Benefits that are of high quality attract and retain top performers, as well as boost morale.

More commitment

W-2 employees are employed by a startup for an unspecified period of time (presumably for the long-term) rather than on a project-by-project basis. 

While employees can benefit through job security, startups and employers benefit from having reliable team members. When they have a consistent team in place, founders can quickly assign work to the employees and free up their own time.

More control

Startups and employers like this advantage because it gives them more leverage over their employees. Employees' preparation, work schedules, and duties are set by their employers. 

The best part?

Hiring an employee to perform or complete a job in a particular way might be a smart decision for a startup. Furthermore, some employees prefer consistency and predictability in their work schedules, so a systematic approach towards the work might even improve their job satisfaction.

From an employee's perspective, there are benefits and limitations to 1099 employment.

Benefits of being a 1099 Employee

Flexibility

Look:

From an employee's perspective, you have more job versatility as a 1099 employee. In a way, you are your own boss. 

Since you are not bound to a particular employer, you have more latitude to choose from a variety of assignments that fulfill your wants and needs -- and to reject those that do not. 

That’s not all ...

Since the final product is mostly always prioritized over the period it takes to accomplish a job, you'll have more scheduling flexibility. Thus, individuals, including parents of young children or retirees, looking to supplement their income can benefit from a 1099 arrangement.

Greater Earning Potential

As a 1099 employee, you technically have no income limit, unlike in a traditional employer-employee relationship. 

There are no restrictions on the number of hours you will work, and you can set your preferred rates and conditions with potential customers. Since the startup does not contribute to your retirement plan or offer fringe benefits, you can charge more for similar services than in-house employees. 

Zero Tax Withholding

As a 1099 employee, you will have more leverage over your tax situation. Since self-employed individuals are not subject to an employer's standard withholding of federal, state, or/and local taxes, nothing is deducted from their wages. 

You are compensated in full for the services you provided. This will assist you in meeting your short-term final commitments and could potentially increase your cash flow. 

Unless you qualify for certain exceptions, the IRS allows you to make quarterly estimated tax payments, and if you underpay, you will face penalties.

Tax Deduction

Independent contractors are considered self-employed business people by the IRS, which means you could deduct a range of different expenses on your tax filing. 

How can you actually use this?

Examples of deductible expenses are:

  • Health care premiums
  • Office equipment
  • Vehicle and travel costs
  • A portion of energy costs 
  • A percentage of house rent and mortgage installments 

As a result, keeping accurate and detailed records of all expenditures incurred in the course of your work-related activities is important.

Limitations of Being a 1099 Employee

Spending time on marketing endeavours

As an independent contractor, you must devote time to promoting your services in order to maintain a steady stream of work. 

While it is entirely up to you how you market your business, keep in mind that every minute you spend marketing is a minute you are not being paid for doing actual work. Concentrate on marketing strategies that tend to yield predictable results so you can devote the majority of your time to clients. 

Some strategies to consider are:

  • Advertisements in local newspapers
  • Providing discounts or special deals to clients
  • Attendance at professional networking events and activities

Lack of Benefits

When you function as an independent contractor, you are responsible for your own benefits. 

You must buy a policy and pay a premium from your own pocket if you want health care coverage. You're also in charge of establishing and financing your own retirement plan. If you're not sure about the advantages and disadvantages of each strategy, talk to a financial advisor about which one better suits your investment goals.

We can help!

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Citations

  1. What are the benefits and trade-offs of having 1099 employees versus W2 employees?
  2. Pros and Cons of Being or Hiring an Independent Contractor
  3. What Is a 1099 Employee and Should You Hire Them?
  4. Independent Contractor (Self-Employed) or Employee?
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