Your Solo 401(k) Plan — Employees, 1099 Contractors?

Recently, I wrote a blog on self-employed individuals who may make the decision of hiring an employee or retaining the services of an independent contractor for their business.  Okay, before you tune me out, I understand that many of you are self-employed with no employees and will never have any employees or work with independent contractors.  In fact, you may not ever even dream of this occurring in your life as a self-employed individual.

But, just in case…what if you did hire an employee(s)?

The blog warned of potential ramifications of such a hire on your ability to continue your Solo-K plan without having to include the employee in the plan.  A Solo-K plan is also referred to as a Uni-K, self-employed 401(k), one-participant 401(k) and self-administered 401(k).

The blog pointed out another potential option to hiring an employee…retaining the services of an independent contractor…also known as a 1099 person.  But, this decision and action should not be taken lightly and certainly without discussing with your tax professional.  The reason being is that there are state and IRS regulations on this subject, with the individual needing to meet the IRS’ definition of an independent contractor.  The IRS, undoubtedly,  is also concerned about collecting payroll taxes, etc. if an individual should truly be classified as an employee vs. independent contractor.  The penalties to an employer can be pretty stiff if you do not classify an individual as an employee IF they meet the IRS definition of being an employee.

Is the Individual and Employee or Independent Contractor?

Well, guess what?   Would it shock you if I told you that just because you might classify someone as an independent contractor, the IRS may not agree with you?!   Of course you want to give serious consideration to whether your business may even have the need for assistance….whether by hiring an employee or retaining the services of an independent contractor.  However, if you hire/retain the services of either type of individual, there are critical aspects that can impact you and your business….even, if your business does not sponsor a 401(k) plan.  So proceed cautiously.

If You Affirm These 4, You May not be Sore

IRS rules governing employees and 1099 individuals are important to learn.  Unfortunately, too many self-employed business owners take a position of, “I am not going to hire an employee….I will just get a 1099 person.”  But, it is not necessarily that easy.

As noted earlier, if you play too close to the margin on this issue by calling the individual an independent contractor (vs. an employee), and the IRS comes back later and challenges your position…your business may be subject to fines and penalties if it is determined the individual should have been classified as an employee.  Before you make that decision, are there any tools that can help guide you on whether the individual should be classified as an employee vs. 1099?  YES!

There are approximately 20 conditions which the IRS uses to determine if the person in question is actually an employee.  If, as a business owner, you can honestly answer YES to the following 4 questions, the individual being retained should be considered truly independent and not an employee.

1)  Profit and Loss — Can the worker you retain truly be able to generate profit OR suffer loss by doing work for you?  In simple terms, aside from receiving compensation for work, can they incur loss (showing they have skin in the game and are not just an employee doing work for your business).

2)  Equipment and Facilities — If the worker you claim is independent, but using your equipment and facilities to do the work, there may be serious questions as to whether they are truly independent.

3)  Working for Multiple Companies — While not totally conclusive due to the fact that an employee can work for multiple companies, does this individual do similar work for other companies?  The more this can be shown, the better the odds the individual would be considered to be 1099.  For example, if I was a courier but only did courier work for one company (even if I used my own equipment, etc.), I could be viewed as an employee.  In contrast, if I did courier work for multiple companies, it should indicate that I am independent contractor.

4)  Services Offered to General Public — Does the worker provide services to the general public.  Does the person advertise these services?  These are general issues that will greatly impact the person’s claim they are independent in the provision of such services.

These 4 questions (if you can answer YES) should be an initial indication whether the person working should be considered an independent contractor.  In the next two blogs, we will look at 16 other questions (issues) for you to look at in determining whether the worker should be considered an employee or independent contractor.  In contrast to this blog, if you answer YES to the 16 issues, if will probably indicate that the worker in question is actually an employee in the eyes of the IRS (vs. an independent contractor).

As always, the information provided is intended to be educational in nature.   It is not intended, nor should it be interpreted as, any form of tax, legal, financial or investment advice.  You must always consult with a respective professional in all such matters.