• The IRS has found that when an individual is responsible for paying his/her own taxes, etc., many times it is not as much as it would be when the employer is paying the correct tax amount. This is primarily due to contractors taking full advantage of any potential business deductions so that they pay less in taxes.

Why do your clients want to pay contractors on a 1099?

• Managers are trying to meet budget constraints. When a company pays a contractor on a 1099, the employer avoids the cost of employee benefits, employer taxes, etc. These taxes can be between 13-19% of the contractor's pay. To many managers, these savings are well worth the risk of misclassifying.

• Managers do not want to pay according to the Fair Labor Standards Act, FLSA (overtime pay). In addition to not paying employer taxes, when a manager pays on a 1099, they do not need to follow the guidelines of the FLSA. The biggest impact of this is in overtime hours worked. According to the IRS, a person paid on an hourly basis must be paid time and one half for each hour worked over forty hours (there are a few exceptions to this rule, see FLSA write-up for more details). By paying on a 1099, the employer avoids this extra expense.

• Contractors are insisting on it. Many uninformed contractors insist on being paid on a 1099. The impact of misclassifying is much greater on the client. This leaves the burden on the client to determine whether or not they are true independent contractors. Many contractors feel that they should be paid on a 1099 because they are only doing a project for the client. Many individuals, especially the ones with rare skill sets are demanding that they be paid on a 1099 or they will go elsewhere. Unfortunately the client is the one who faces the most in fines, etc., if and when there is an audit. The contractor may have to pay back taxes, etc., but the IRS usually goes after the entity with the "deepest pockets." It is easier for the IRS to audit and collect penalties from one company than from hundreds of individuals.

Why do recruiters want to make placements on a 1099?

• The profit margins can be greater. Recruiters stand to earn more money when their candidates are paid on a 1099. If the bill rate is comparable to other bill rates, the recruiter can take a larger portion of the margin, because employer taxes are not taken out.

• It can be an easier sell to the client. There is no need to follow the FLSA which dictates that time and one half must be paid in most instances. The client just gets one simple bill rate and avoids any overtime issues.

If this is illegal, why are so many companies doing it?

• They have not been audited, yet. Many companies and contractors thought they found a loophole in the tax laws and decided to utilize the form 1099-misc. This may be a great fix for those that have not yet been audited. Unfortunately, the IRS has decided to crack down on the misuse of this form. For many companies and contractors that have not been audited, this still seems to be a great solution; the reality of misclassifying has not had a negative impact on these people.

• They have the attitude, "if it is not broken, don’t fix it." By never experiencing an audit by the IRS, or having to pay back taxes and fines, it is difficult to persuade clients and contractors that it is risky or that it is wrong. Many clients may say that they have always done it this way and don’t see any reason to change.

• They do not know it is illegal. Many companies may not be current on all laws. Years ago, the IRS’ crackdown on 1099s vs. W-2s was not as great. As they have found abuse of classifications, they have increased their focus on this problem. Many clients may not be aware of this and therefore continue to misclassify, simply due to lack of knowledge.

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