EOR: Employee Classification – 1099 vs. W2


Using an employer of record (EOR) service yields many benefits to an organization and this blog has written fairly extensively on those benefits in posts here, here and here. To recap, the general benefit of engaging an EOR is the dramatic reduction in administrative burden the customer experiences when they outsource these functions to an EOR.  For the typical W2 job role, engaging an EOR is a very low risk and moderately high reward proposition.  However, when an organization requires project work to be performed by a 1099 or an SOW, they must understand that the thorny issues surrounding IC classification don’t belong entirely to the EOR even though they assume responsibility for tax administration as the employer of record. In fact, there exists a joint liability for ensuring that proper 1099 classification is performed. Here’s what you need to know if you’re using an EOR to manage 1099s.

This article from Forbes explains that whether a contingent worker is sourced via a staffing supplier or through an EOR 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.”

Making the determination about whether a worker is a W2 contingent laborer or a 1099 contractor therefore becomes somewhat of a joint decision for a customer using an EOR.  If an organization is not utilizing any independent contractors, project workers or SOWs, then they can rest assured that the EOR will handle all appropriate tax and benefits administration requirements without any need for client involvement. However, if any number of 1099s are expected to be included in the overall workforce mix being covered by an EOR, then the same classification protocols apply. 

Best practices dictate that the customer establish clear, written guidelines for 1099 classification at the inception of the EOR engagement, and that they perform periodic audits to ensure the EOR is keeping compliant. The guidelines should adhere to the “three categories” the IRS uses to identify the characteristics within the worker-employer dynamic which indicate a resource should be classified as either a 1099 or a W2.  To refresh, those three categories are:

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.

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

Relationship Between Parties – 1099 contractors typically do not receive benefits such as paid leave and medical insurance whereas W2s do. 1099s often perform services for multiple parties while W2s typically do not.

For instances where the three categories still do not provide enough clarity about a worker’s classification, organizations can still use the more detailed 20 Factor Test provided by the IRS.  Both protocols are published in detail at the TaxCareerDigest.com site here.

The bottom line is using an EOR for anything outside of W2 labor requires a greater level of involvement on the part of the employer. The EOR is not to be used as a means to avoid liability and, in fact, it does not provide such protection when 1099s are involved.  So weigh options carefully and if you do decide to engage an EOR, make certain there is a clearly enunciated policy for classifying all workers.

Posted in Blog, EOR Services