Some clients who plan to only serve non-U.S. customers and live outside the U.S. may be able to reduce their income tax burden by paying themselves as an independent contractor.
However, if a US court or the IRS determines a person your company hired as an independent contractor is, in fact, an employee, you can face liabilities for not meeting the requirements of employment.
So what are the criteria for being an independent contractor?
According to IRS definition, people who are in an independent trade, business or profession offering their services to the general public, are generally independent contractors. The payor for independent contractors has the right to control only the result of the work and not what will be done or how it will be done.
What are the differences between a contractor (1099) and an employee (W-2)?
Here are three types of questions to distinguish between the two:
Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? If the answer is “yes,” s/he is likely a W2. If the worker is free to manage their own schedule and work process, they are more likely a 1099.
Financial: Does the employer control the business aspects of the worker’s job? This includes for example, how the worker is paid, whether expenses are reimbursed, and who provides tools or supplies. If the company controls how the worker is paid and pays for expenses and supplies, s/he is likely a W2. If the worker has to send an invoice to get paid and/or cover their own expenses, they are more likely a 1099.
Type of relationship: Do you have a written employment contract (versus project or an independent contractor agreement) or employee-type benefits, e.g. health insurance, vacation pay? Will the working relationship continue for the foreseeable future if the work is done correctly and is the work performed a key aspect of the business? If the company provides an employee with benefits and believes the employee is there for the long-term, s/he is likely a W2. Only ONE of the questions has to be met for the employee to be considered a W2 employee.