The Internal Revenue Service promulgates rules and regulations concerning the employment status of workers. In general, workers are classed as W-2 employees and certain tests must be met to have the worker classed as a 1099 subcontractor. All 1099 subcontractors should be issued a Form 1099 in January of each year for the prior calendar year of services. This article describes the general tests that must be met for the worker to be considered a 1099 subcontractor.
There are four general guidelines that must be met prior to the contractor considering the worker a 1099 subcontractor. These are licensing, insurance, contract and control. The attributes of each are discussed below. Remember, these should be met in order for the contractor to consider the worker an independent contractor (Form 1099 Subcontractor).
There are several different forms of licenses for every business. Depending on the nature of the business and the restrictions from each state, certain licenses must be held by the worker. The primary license required is a business license. The local Commissioner of the Revenue issues business licenses once the worker pays the fee. See https://businessecon.org/2012/12/local-revenue-tax-the-business-license/ for more information. In addition to the license, the worker provides information on his/her tools and equipment to the Commissioner for property tax purposes. This is one of the primary indicators of seeking independence as a small business operation thus justifying a contractor/subcontractor relationship.
Other forms of licenses include those legal guidelines issued by the state or a state board of regulators for that type of service. Traditional state issued licenses include:
- Construction trades – electrician, plumber, HVAC, Gas, Septic Tanks, Wells
- Salon trades – hair stylists, barbers, nail technicians, masseurs
- Medicine – Doctors, nurses (RN’s, LPN’s, aides), radiologists, dentists, hygienists
- Law – lawyers, court recorders, clerks
- Engineering – Engineers (chemical, mechanical, electrical, architects), surveyors, inspectors
- Real Estate – brokers, agents, appraisers
- Others – auctioneers, agriculture, taxidermists
Having a state issued license for your trade is a key indicator of business independence. Although an indicator, it may not be enough justification to classify the worker as a subcontractor. There are other tests that can or have to be met to indicate subcontractor status.
The primary form of insurance to substantiate subcontractor status is workman’s compensation insurance. All states have insurance laws and regulations for workers. The primary goal is to provide the medical care and long term care in case of a serious injury on the job. If the subcontractor provides evidence of insurance to the engaging organization, this is a clear indicator of independence and small business status. Other forms of insurance include professional liability, property and equipment insurance and forms of medical disability protection. For the contractor, you are looking for what is referred to as binder coverage. The binder is the cover sheet that identifies the different policies and the respective limits for those policies.
Many of the contracts for work are verbal. Some are simple documents identifying price and the type of work to be done. But a documented agreement between the two parties is a clear sign of a contractor/subcontractor relationship. In some situations, it is a good idea to have a very detailed agreement between the two parties. These include construction type contracts, artist work, and website development. Examples of industries that use contracts between the contractor and subcontractor include real estate, construction, engineering and law.
This particular test is met if control is transferred from the contractor to the subcontractor. Control elements include time, end results and methods of performance.
The time test is met if the subcontractor is given a reasonable deadline to complete the work. The end results test is based on some form of performance standard. The best tool to identify completing a level of performance is a third party inspection such as a local governing inspector issuing the permit or certificate of completion. Another simple example of a third party endorsement is the haircut received by the customer is satisfactory thus the barbershop gets paid by the customer and then the barber receives his/her commission. Other examples of meeting the performance test include materiality compliance such as delivering goods or the product functions as required.
The methods of performance test are used to determine who controls how the work is done. If the contractor dictates the how e.g. ‘Do it my way’, then control has not passed to the subcontractor. This lack of control by the subcontractor may trigger the employer/employee relationship in the eyes of the IRS. Other elements of this test include who provides the tools, does the subcontractor do the work on his own, and/or who controls the environment for the work.
The Internal Revenue Service looks at the totality of the relationship to determine the status of the worker. If the industry has a traditional contractor/subcontractor relationship like in real estate between the broker and the agent, then they look to see that the agent has purchased a business license, acts in a manner similar to other agents etc. The four tests above are the clearest indicators in the eyes of the IRS that there is indeed a contractor/subcontractor relationship. As a small business owner you need to understand these general guidelines in determining the status of the worker. Act on Knowledge.