Taxes

New Test for Categorizing Workers: The 1099 Final Rule

May 13, 2021

Categorizing workers as an independent contractor or employee can be a challenge. Here is what you need to know about the 1099 final rule.

New 1099 Test Cover Image 1

Introducing the 1099 Final Rule

Some businesses struggle with determining whether a worker is truly an employee or an independent contractor.  This is because sometimes the line between the two is a bit blurry. Really, it’s no wonder there is confusion.  If you look at the history of differentiating between an employee and an independent contractor, there have been a variety of tests to try to help clear up uncertainty.

This year, the U.S. Department of Labor has yet again attempted to clarify the criteria determining worker type.  So, here is the backstory and what you need to know about the 1099 final rule.

A Sales Rep’s Backstory

Way back when I first began selling payroll, I faced a frequent barrier to entry when I was cold calling small businesses.  The barrier was something many payroll sales reps encountered then, and probably do to this day.  I can still see the receptionist shrugging and saying, “We don’t need a payroll service because we don’t have any employees.”  I would look around the office space, quickly counting heads, making a mental note of how many people appeared to be working right there within my view.  If I was lucky, the owner’s business card would be sitting in a cardholder, and I could snag one on my way out.

Photo of a worker talking with a customer (who appears to be about to do something on her smartphone) at a cash register.

Once back at the office, I’d jot down a few notes about what I saw in that workplace.  Workers in desks, all using the same computers, type of pen, and notepads.  That was usually the tipoff—uniformity.  If I had seen employees using a unique set of tools (a Mac instead of a PC, for example), then I might agree that the workers were truly independent contractors.  However, if the workers’ tools were provided by the company, there is a good chance those workers would be considered employees.

The Essence of the Job

More important than the worker’s tools, however, was the essence of the job.  Steve Curtain says all job roles are made up of two things: the job function and the job essence.  The function is what a worker does at work, and the essence is the worker’s purpose for performing those tasks.  Our sales managers encouraged us to focus on identifying the essence of the job when trying to help companies determine if they had contractors or employees working for them.

Improperly Categorizing Workers

So, why wouldn’t a business owner try hard to make sure they have properly categorized workers?  Well, one possible reason is that it requires extra thought to do so.  Some business owners simply don’t understand what constitutes an employee.  So, it would be easier just to pay all workers with a 1099 form.

Related:  IRS Adjusts 2018 HSA Contribution Limits for Family Coverage (Again)

Another reason business owners might not properly categorize workers is the tax aspect.  Having employees requires the business owner to withhold and pay taxes on the employee’s behalf.  It also requires business owners to pay the employer portion of taxes.

Even though it may be a bit thought-intensive, try pushing the excuses aside to figure out what kind of worker you have at your place of business.

The 20 Factors Test

Long before I began selling payroll, the 20 Factors Test was the tool used to determine if a worker was an employee or an independent contractor.  This test gave a long list of if-then scenarios to try to guide a business owner to a determination of the type of worker they had.

The Right-to-Control Test

Photo of a man looking at his computer with a pensive expression.

The 20 Factors Test was also commonly called the “Right-to-Control Test” because the questions were intended to ultimately indicate the controlling entity for the work performed.  Finances and performance/behavior are two aspects controlled when in an employee/employer relationship.  Additionally, employers control the benefit offerings to their employees.

The Economic Realities Test

More recently, we saw the Economic Realities Test emerge.  This test differs from the Right-to-Control Test in that it has variations in the definition of what it means to be an employee.  Furthermore, the Economic Realities Test is also used to determine worker type for the purpose of FMLA.

Among the questions included on the Economic Realities Test, business owners will consider whether the worker relies on the hiring party for income.  Also, if the worker is self-supporting and independent to work for others.

The Final Rule – 5 Factors

The final rule is basically an affirmation of the Economic Realities Test.  It consolidates the list and highlights five factors in determining worker type.  Here are the core and other factors:

Core Factors

The main factors, or “core factors,” are as follows:

  • What the nature of the work is, and how much control does the business owner have over the worker?
  • Can a worker earn or lose additional money within the scope of the work?

In other words, is the business owner telling the employee when to arrive, how to do the work, and with what tools?  And can the worker lose money if they don’t do the job correctly?  If the answer to these questions is “yes,” then the business owner likely has true employees.

Other Factors

Now, there are supplemental factors to consider, as well.  The other factors of the Final Rule are meant to sway the determination if it is gridlocked, or confirm the determination when in doubt:

  • How much skill does the work require?
  • What is the longevity of the task or project?
  • Is the task or project an integral part of the business’s operations.?
Related:  Getting FIT: Learn How Federal Income Tax is Calculated

So, will the worker be performing the task permanently, or will their job end when the task is complete?  Permanence would indicate the worker is an employee.  And does the task require special skills or training?  Independent contractors likely have a specialized skillset.  Is the worker’s contribution through the role required in order to keep the business going?  If a business can’t continue operating without the worker performing that duty, the worker is likely an employee.

The final rule was announced on January 6, 2021, but it became official on March 8, 2021.

Concluding the Final Rule

Now, back to my days in sales.  After concluding my research and analysis of the business I had cold called, I had to decide if I would contact the business owner.  The goal was to see if I could convince him/her to reconsider how he/she categorized workers, if I felt the business owner had categorized them improperly. 

Why did I care, anyway?  Well, because if workers are not categorized properly and the IRS finds out, the business owner could eventually be liable for penalties associated with nonpayment of taxes.  Payroll companies want businesses to be in compliance with the law.  After all, why would anyone want small and local businesses to be at risk of closing due to penalties for noncompliance?  However, that’s not always an easy conversation to have with business owners, especially if it means a major overhaul in the bookkeeping process.  Still, it’s not a conversation business owners can hide from forever. So, the moral of the story is, it’s imperative that businesses properly categorize their workers.  Fortunately, the final rule for the 1099 test helps guide employers to feel confident in their analysis.

New 1099 Test Image 3


Subscribe to our newsletter

Get the latest from the world of payroll & HR delivered straight to your inbox!

Thanks for your interest!