A 1099 worker, or contractor, is filed differently from a traditional full-time W-2 employee. While employees are eligible for benefits including worker’s compensation and federal unemployment, 1099 contractors are not. Businesses often utilize 1099 contractors to perform work that may not include a long-term need or that is an inconsistent job. For example, construction workers are often classified as 1099 workers if they are brought on to complete a short-term job.
In some cases, businesses might not see the need to complete official filings for their 1099 contractors. If they’re simply hired for a short-term project or operation, business owners and managers may attempt to get away with avoiding the processes of registering each of their individual 1099 contractors. Regardless of their length of employment, employers are required to report all 1099 workers.
That being said, making such a decision can negatively impact your business. Should the Employment Development Department (EDD) decide to audit your business and find that either your 1099s are unclassified or that they’re incorrectly classified, you’re sure to find yourself in hot water as part of an EDD audit. Audits often result in significant fines and penalties that can cost you a significant amount.
In addition to the threat of a potential audit from EDD, failing to claim your workers as 1099 contractors leaves them with no official proof of income. Independent contractors rely on their 1099 documentation to correctly file their tax returns and cannot do so if they are not provided with proper documentation of their employment and taxes withheld. Should this be the case, not only is your business at risk of an audit, but your workers likely are too.
On top of not being able to correctly file their taxes without 1099 income documentation, workers will also lose the opportunity to apply for a loan without proper documentation of their income. Having official 1099 documentation provides banks and lenders with the proof they need to confirm an individual’s income to enable them to process loans for things like homeownership, car purchases, etc.
In addition to the obvious negative effects, it has on your workers, failing to file proper 1099s for your contractors has the potential to have a negative impact on your business valuation. Paying workers “under the table,” another term for employing undocumented workers, means that your business cannot track the expenses involved in your projects.
If your business has no way to provide evidence of your expenses, not only will you be unable to truly calculate the return on your business investments, your business’s true valuation, but you will also have difficulty proving your need for capital should you decide to pursue external funding.
Overall, there is a multitude of reasons why business owners should ensure that they have proper documentation for all of their 1099 workers. Whether it be to benefit the business directly or the workers themselves, it’s crucial to the success of your business’s future to properly document the appropriate tax requirements.
If your business is being audited by EDD or needs support in correcting your tax documentation, reach out to our team of legal experts at Milikowsky Tax Law.