Entrepreneurship in the United States has undergone a fundamental shift. Services have replaced manufacturing as our primary growth driver. On one hand, this has created a skills gap for many in the workforce. On the other hand, it has also created new self-employment opportunities, particularly through freelancing. If you are a freelancer, or utilize freelancers in your small business, you know that freelancing gives individuals an opportunity to take more control of their own professional destiny and is often a first step in establishing a business that grows and employs others.
Small business growth is the pre-eminent growth catalyst for the U.S. economy. There are approximately 28 million business owners in the U.S. alone, including many solo business owners. In cities like Chicago, small businesses employ half of the workforce. This means that we should be highly focused on creating a favorable business environment where small businesses can grow and thrive. However, the U.S. tax code hasn’t kept up with the changes in the business environment and the needs of small business owners like us.
One simple definitional change in the tax code – revising the definition of an independent contractor, aka a 1099 worker – would provide substantial support to help foster a pro-small business environment.
If you are confused by the difference between a 1099 worker/independent contractor and an employee, you are not alone. Per the IRS, “Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.”
This may seem like a small distinction, but to small business owners who are already consumed with burdensome administrative tasks, not to mention a cost structure that may not be yet scalable, it is a significant one.
Small businesses make extensive use of independent contractors and freelancers as a way to fill in gaps in their business. However, the IRS says that if you perform work that would be done in the normal course of business by an employee (including, amongst other things, not setting your own hours or methodology for completing the work), you are considered an employee, not an independent contractor, for tax purposes. This stands even if you own your own firm, have additional clients and/or just plain want to be one.
It is very clear that this outdated definition creates a barrier to hiring for small business owners. It means that a freelancer may be considered an employee by IRS standards, creating additional paperwork and compliance for a small business owner. This outdated rule affects small business owners on both sides – impeding the hiring company from growth and the freelancer from getting more work. If a small business only needs a person for projects, shortened hours or even for part of the year, having an expanded 1099 definition would allow an independent contractor to be able to be employed by multiple businesses without creating redundancy in administrative work and other paperwork.
What is the stress and burden for going from no employees to one employee like for a small business? If you have been there before, you know that it is significant. It affects a business through the cost and time of payroll and reporting. Plus, there is other compliance that is necessary when you have employees (such as legalities regarding hiring, firing and more). It may also affect the structure of one-person business’s retirement plan.
Independent contractors who are paid more than $600 a year by a business and have a non-corporate entity (LLC, Sole Proprietorships) issue hiring firms a form called a W-9. The hiring firm then files a form 1099-MISC with the IRS each year to report those payments. If the government and the IRS are concerned about income reporting, this 1099 reporting should take care of that concern.
If both parties are in agreement that an independent contractor arrangement makes sense, why would the government stop that? Income and other taxes are still getting paid. While businesses pay and collect Social Security and Medicare taxes (aka FICA taxes) for each employee, an independent contractor is subject to self-employment taxes, which cover both Social Security and Medicare contributions in an amount roughly equivalent to the FICA tax. So, why should the government and the IRS care which entity is responsible for those taxes? Shouldn’t that be up to the parties in the work arrangement? Allowing more individuals to work as independent contractors as they are hired by other businesses should actually increase tax revenues by making it easier to put people to work and for companies to grow.
With an estimated 22 million of the approximately 28 million small businesses in this country being one-person entities, recognizing the need to change legislation to support freelancers is an important step towards giving small business owners a real voice in Washington.
Carol Roth is a national media personality, ‘recovering’ investment banker, investor, speaker and author of the New York Times bestselling book, The Entrepreneur Equation. She is currently an on-air contributor for the national cable television station CNBC, the pre-eminent name in business news, and the host and co-producer of The Noon Show, a current events talk show on WGN Radio, one of the top stations in the country. Carol multimedia commentary covers business and the economy, current events, politics and pop culture topics.
Carol has helped her clients complete more than $2 billion in capital raising and M&A transactions. She is a Top 100 Small Business Influencer (2011 &2012) and has her own action figure. Twitter: @CarolJSRoth