EOR: Employee Classification – 1099 vs. W2

Organizations generally benefit from utilizing an employer of record (EOR) employee service to relieve them of many administrative burdens, especially in the payroll and staffing departments; we explore those benefits extensively on our blog here, here, and here.

What Is an EOR?

An employer of record is a third-party provider that has legal responsibilities for another organization’s employees. For client companies, it can be a domestic provider within the same country or a foreign entity in another country with different employment laws. It is the legal employer on behalf of a client company, which includes complying with local employment laws and local labor laws, as applicable.

An EOR handles employment administration, including management of payroll processing, contributions for health insurance, comprehensive and statutory benefits for employees, and compliance risks. An EOR assumes complete legal responsibility, while the client business remains in charge of managerial or day-to-day duties.

This arrangement can help significantly offset employer burden costs, retain valuable talent, and be instrumental in maintaining employment contracts. If international, an EOR can help navigate pertinent labor laws of the client business’s local country, assess the host country’s legal landscape, manage payroll and tax deductions, and more. This can be incredibly helpful for companies that need to solve a distributed workforce budget effectively or that have international employees.

Employer of Record: W2 and 1099 Classification

For typical W2 job roles, staffing through an EOR employee service is a very low-risk, cost effective, and moderately high-reward proposition. For instance, an EOR can help provide and offset accurate employer burden calculations for a business. However, when an organization needs to hire independent contractors (IC) through 1099 or Statement of Work (SOW) for project work, they must understand that IC classification responsibilities don’t belong entirely to the EOR—a joint liability exists to ensure that your organization, in some manner, performs the 1099 classification properly. 

Here’s what you need to know if you use an EOR employee service to manage 1099s:

Traditional Staffing vs. EOR Employee Service

Forbes explained that, whether a contingent worker is sourced through a staffing supplier or through an employer of record arrangement, “There is no bright-line rule for when a company could be found to be a joint employer with another company, subjecting both to various employment laws. But, generally, a company will be deemed a ‘joint employer’ with another company if it has ‘direct and immediate control’ over another company’s employees.”

Classifying Organizational Roles

Discerning whether a worker is a W2 contingent laborer or a 1099 contractor becomes a joint decision for a customer using an EOR employee service.  Suppose an organization needs to utilize independent contractors, project workers, or SOWs. In that case, they can rest assured the EOR will handle all appropriate tax and benefits administration requirements without client involvement. However, the same classification protocols apply if you expect to include any 1099s in the overall workforce mix your EOR covers. 

Best practices dictate that organizations clearly establish written guidelines for 1099 classification upon engaging EOR employees and staffing services, and perform periodic audits to ensure the EOR stays compliant. The guidelines should adhere to the “three categories” the IRS uses to identify the characteristics within the worker-employer dynamic, which each indicate whether to classify a resource as either a 1099 or a W2.  To refresh, those three categories are:

#1: Financial Control

ICs can realize a profit or loss, have made significant investments into the tools of their trade and workplaces, and are generally not reimbursed for business expenses.

#2: Behavioral Control

W2s perform work tightly controlled by the employer, who mandates how, when, and where the worker will perform. If the employer provides training on their methods and processes, the worker is likely a W2.

#3: Relationship Between Parties

1099 contractors or contract staffing typically do not receive comprehensive benefits packages such as paid leave and medical insurance, whereas W2s do. 1099s often perform services for multiple parties, while W2s usually do not.

For instances where the three categories still do not clarify a worker’s classification, organizations can still use the more detailed 20-Factor Test provided by the IRS.

The Bottom Line

The bottom line is that utilizing EOR employee staffing services for anything outside of W2 labor requires greater involvement from the employer. The EOR is not to be used to avoid liability; it does not provide such protection when 1099s are involved, anyway. So, weigh your options carefully, and if you decide to engage an EOR, ensure there is an enunciated policy for classifying all of your workers.

For More Advice on Staffing Solutions

To learn more about EOR employee classification and other staffing solutions or to find help attracting exceptional talent, turn to our workforce management experts at nextSource, an industry leader and global EOR partner!

Navigating global markets can be tricky, especially with a myriad of local labor regulations to adhere to. That can make hiring international employees a real roadblock or the need to hire local talent all the more paramount. Contact us today for international EOR services as well as local, and we’ll help you develop and implement strategies for optimal performance in all management areas, including employment of record services, to suit your organization’s specific needs.