When you started your business you may have had to make a decision…are your employees going to be W2 and 1099? It’s not a small matter, but one with long-lasting impact on how you do your business and whether the IRS comes to visit you on the issue. It can also help protect you against payroll fraud issues.
Put succinctly, W2 employees are “internal” employees. You determine where and when they perform their work. You may have a dress code for them, as well as other workplace rules that they have to adhere to. 1099 employees are commonly freelancers or “independent contractors.” You pay them for a specific task which they can do where and when they want, usually using their own equipment and space.
Employers deduct federal, state, and employment taxes from a W2 employees paycheck, while 1099 employees are required to report their income and business expenses, then pay the taxes themselves.
It is considered an IRS “best practice” to not have employees receiving compensation under both W2 and 1099 structures at the same time…and some organizations have policies in place to prohibit doing so…which is what happened recently in our neighborhood.
How It Can Go Really Wrong…
The Parks Director in East Ridge, Tennessee, along with two other city employees, recently resigned because of a payroll fraud investigation. The city has a policy against paying people on both W2 and 1099 simultaneously, but a couple regular (W2) employees of the city also wanted to make some extra money working as umpires for baseball games at a local ball field. The umpires are paid as 1099. (It really is more complicated than this…if you want to get deeper in the weeds, check out this article at the Chattanoogan.)
The solution they used was to receive the 1099 compensation under another person’s name and Social Security Number. Even when both parties agree to this scheme, it is still illegal and prosecutable by the IRS.
In this case, the employees themselves were not the only ones to risk big trouble. The Parks Director took the fraudulent W9 forms from the employees, then produced time sheets that reflect the time worked in someone else’s name. So now three people were liable for criminal charges. Thankfully for them, because the matter was reported and corrected, the employees all resigned, and the amount of the payroll fraud was less than $500, no charges were filed.
Protect Yourself…and Your Company!
The Parks Director and the employees in question were all in agreement on how to deal with the situation. But they were reported by a family member. So just because you and your employee agree upon how to deal with something…just because you have a “handshake agreement”…doesn’t mean the practice is legal or ethical. You might think it’s a secret between you and your employee, but what if the employee has a family member that knows and decides to intervene? What if you and the employee have a falling out over a different matter?
The best practice is to always protect yourself and protect your business. Do things legally from the start. Maintain high ethical standards at all times. If you have questions or need help staying in compliance, you can always call us here at Southern Payroll & Benefits, 423-207-2497.