The way you hire a worker determines whether they are a W-2 employee or a 1099 contractor.

IRS defines the decision of whether to classify your employees as a contractor or employee by three categories – behavioral control, financial control, and the relationship of parties. The outcome of their position in each of these categories determines whether they be classified as an independent contractor or employee. 

Behavioral Control

Behavior control describes the ability that an employer has to instruct employees to do certain tasks. A person is classified as an employee if the business for which they are working has control and direction of the work they perform. 

Some examples of behavioral control include the following:

• Type of instruction given: such as when and where to work
• Degree of instruction: less detailed instructions illustrate less control, meaning that the worker may more likely be an independent contractor
• Evaluation systems: evaluation systems serve to evaluate how the work is done. In the event that only the final product is evaluated, your worker is more likely an independent contractor
• Training: Training a worker on how to do their job points to them being an employee. Independent contractors hired to complete a job are often already well versed in the job for which they’re responsible.

Financial Control

Financial control assesses whether the employer has the right to control the finances of a worker’s job. For example:

• Investing in equipment that a worker uses to work for someone else
• independent contractors are more likely to experience unreimbursed expenses than employees
• Opportunity for profit or loss is a sign of an independent contractor
• Independent contractors offer services to the market, meaning they are free to seek out new business opportunities
• Method of payment: While employees usually receive a regular paycheck for a certain amount of time spent, independent contractors are often paid a flat fee for their services. 

Relationship

The relationship between a business and a worker is dependent on how the worker and business perceive their interaction with one another. Situations that may help distinguish between the two may include: 

• Written contracts that detail the relationship intended (however a written contract classifying a worker as an employee or contractor is not sufficient to determine their status)
• Benefits: Businesses that offer benefits including vacation, sick pay, healthcare, and pension plans typically have employees. These benefits are not usually offered to contractors. 
• Permanence: A relationship that was created with the intention of continuing indefinitely is likely that of an employee. Independent contractors usually serve a short-term contract to complete a specific job. 
• Services are a key activity of the business: If the services being completed by the worker are a key activity of the business, they are likely considered an employee. For example, a cashier at a supermarket is completing a key activity of the business. 

There are significant consequences should you wrongly classify your workers, whether intentionally or not. Doing so can land you in hot water with the Employment Development Department (EDD). EDD is responsible for collecting payroll taxes from millions of employers across California. There are various triggers that may serve as a red flag for them to audit your business. The top 4 triggers include the following:

Independent Contractor Filing for Unemployment

A worker that is correctly classified as a 1099 independent contractor is not eligible for unemployment. If a contractor lists your business in an application for unemployment benefits it raises a red flag to EDD. It may have been that the employee was simply unaware that they are ineligible, but EDD usually takes this as a sign that they may be an incorrectly classified worker. 

Employee Complaint

If an employee, or an anonymous source, files a complaint against a business to EDD, there’s a high possibility that they will decide to audit that company. 

Employees may decide to file a complaint against their employer to EDD for multiple reasons. If they have not been paid on time or are incorrectly classified against their will, they may decide to file a complaint to EDD. If a complaint is filed against your company, EDD will likely perform an audit to investigate the employee’s claim. 

Complaints can be filed by directly contacting EDD. Employees may file complaints regarding unemployment, payroll, disability, and more. If you think that you may have had an employee file a complaint against your business, your safest option is to contact a tax attorney immediately to ensure that you are prepared in the event of an audit. 

Late Filing of Taxes

EDD requires businesses to file a variety of various forms throughout the year. This includes filing information about your employees, independent contractors, payroll taxes, and quarterly returns. These forms each have very specific annual due dates. 

If your business does not complete the required forms within the correct time frame it may trigger an EDD audit. That said, regardless of whether or not your business is audited for filing taxes late, doing so will make you responsible for late fees and penalties. 

Randomized Verification Audit

Verification audits are for all intents and purposes, random. EDD uses verification audits regularly to ensure that businesses are following proper guidelines for employee classification and payments. This is the only type of EDD audit that is not the result of a specific allegation or claim against a company. 

As long as you are consistently taking responsibility to ensure that your tax and payroll filings are correct, a random audit should not be a problem for your business. EDD prioritizes audits of businesses that they suspect may be guilty of wrongdoings, but that doesn’t mean it’s impossible for even innocent businesses to be audited. A verification audit is the only type of audit that does not result from a suspected wrongful act. 

For more information or to assess the classifications of your workers, reach out to our team of experts at got1099.