Time to rethink that 1099 strategy?

I had seen their trucks all over town.  How many employees do you have?, I asked. 

Six employees, he answered, plus 20 service techs that we 1099. 

Using 1099 as a way to avoid workers comp risk, unemployment risk, and even payroll tax withholding headaches has been a strategy used by many employers for years. Some owners see this as little more than driving 62 in a 55 zone. Yes, technically I'm speeding, but I doubt I'll get caught. Besides, the rules are pretty vague and I'm confident I can justify it if I'm forced to.

On July 15 the Department of Labor released a guidance that defines independent contractor more narrowly than ever before, making those rules a little less vague. And it signaled its intent to prioritize the enforcement of what it considers to be abuses of this practice. This action also emboldens the IRS and the state enforcement agencies to go after employers who utilize a 1099 workforce strategy.

So, what's the risk if I can't convince them that my 1099s are legit? The penalties start at 1.5% of wages, plus interest, plus 100% of the FICA tax the employer should have paid, plus at least 20% of the FICA tax the employee should have paid, going back three years (no matter whether the contractor paid his/her taxes or not). That's if you properly filed the 1099s. If you messed that up, the fines are even more substantial. If the IRS determines you knew the rules but you intentionally violated them to avoid taxes, they can even file felony charges. If convicted, you could potentially spend a year in prison and pay fines of up to $100,000. 

That's no speeding ticket, what should I do? Consult with an HR professional or labor attorney to help you determine which of your 1099 relationships are likely to be considered legitimate by the DOL and/or IRS. They can help you ensure that you have the right documentation in place to demonstrate that the 1099 relationship is appropriate in those cases. They can also help you evaluate alternative workforce strategies for those that will likely be considered illegitimate. If the best alternative is to bring them onboard as employees, they can assist with that migration and any policy implications that result - such as regulations that now may apply to your organization, like FMLA or ACA.

Why do they care?  It's all about tax dollars. When you pay an employee on Friday, you withhold taxes and send it in immediately. When you pay a 1099, the government has to wait until that individual files his or her taxes (presumably quarterly) to get its money. A lot of them don't file until the end of the year (if at all). In addition the state and federal unemployment coffers are still strapped as a result of the great recession. 1099 workers often don't pay into the unemployment system like employers do. All levels of government prefer the steady stream of cash that comes from regular payroll withholdings.

It's so much easier simply writing one check and being done with it? Being a small business owner is hard work. The best surround themselves with smart people to help them navigate through these types of changes and manage their risk so they can focus on their customers and their business. Regulatory changes are never going to stop. In this case, you might as well develop an alternative workforce strategy, because a 1099 strategy is rife with unacceptable risk and it's time to rethink its use.