Hiring Illegal Immigrants on a 1099: What You Need to Know

Hiring workers as independent contractors using a 1099 form comes with specific legal and tax responsibilities. When those workers are undocumented immigrants, the situation becomes more complex due to federal employment laws and IRS regulations. Businesses that fail to comply with these rules can face fines, penalties, or legal action.

Understanding how tax reporting works in this scenario is essential. While immigration status affects work authorization, it does not prevent someone from being paid or taxed.

Worker Classification Criteria

Determining whether a worker qualifies as an independent contractor or an employee is key to tax compliance. The IRS uses a three-factor test: behavioral control, financial control, and the nature of the relationship.

Behavioral control examines how much direction a business gives regarding work performance. If a company sets schedules, provides training, or closely supervises tasks, the worker is likely an employee.

Financial control looks at how the worker is paid and whether they can make a profit or incur a loss. Independent contractors typically provide their own tools and cover their own expenses. If a business supplies equipment or guarantees a fixed wage, the worker may be misclassified.

The nature of the relationship is determined by contracts, benefits, and the expectation of continued work. Independent contractors generally work under a written agreement for specific projects and do not receive benefits like health insurance or retirement contributions. If a worker is engaged indefinitely and treated like an employee, the IRS may classify them as such.

1099 Filing Steps

Once a worker is classified as an independent contractor, businesses must submit Form 1099-NEC for tax reporting if they pay the worker $600 or more in a tax year. The process starts with collecting the contractor’s name and taxpayer identification number (TIN), typically provided on Form W-9. If the worker does not provide a valid TIN, the business must withhold 24% of their payments for backup withholding.

Businesses should track payments throughout the year to ensure accurate reporting. Using accounting software can help prevent errors. When filling out Form 1099-NEC, only payments for services should be reported in Box 1—reimbursements for materials or expenses should be excluded unless they were part of the contractor’s compensation.

The completed form must be submitted to both the IRS and the contractor by January 31. Late filings can result in penalties ranging from $60 to $630 per form, depending on how late the submission is. If errors are found after filing, corrections should be made promptly.

Required Tax ID Numbers

Businesses must ensure independent contractors provide a valid TIN for tax reporting. U.S. citizens and lawful residents typically use a Social Security Number (SSN) or an Employer Identification Number (EIN). Undocumented workers who do not qualify for an SSN can apply for an Individual Taxpayer Identification Number (ITIN).

The IRS issues ITINs to individuals who need a tax ID but are not eligible for an SSN. To obtain one, applicants must complete Form W-7 and submit proof of identity and foreign status, such as a passport or national ID card. Processing typically takes about seven weeks. An ITIN does not grant work authorization; it is solely for tax purposes.

If a worker does not provide a valid TIN, businesses must withhold 24% of their payments for backup withholding and report the withheld amount on Form 945. These payments must be sent to the IRS quarterly. Failure to withhold when required can result in the business being held responsible for unpaid taxes, plus interest and penalties. Employers can use the IRS TIN Matching Program to verify that the provided TIN matches the worker’s name in IRS records.

Maintaining Documentation

Keeping accurate records is essential when hiring independent contractors. The IRS and Department of Labor require businesses to maintain documentation that supports payments and tax compliance. Businesses should retain invoices, contracts, and payment records for at least three years, though the IRS can audit records up to six years back if major discrepancies are found. For payments over $5,000, keeping records longer may be advisable in case of tax disputes or legal claims.

Contractor records should be kept separate from employee records to avoid misclassification issues during an audit. Digital bookkeeping tools like QuickBooks, Xero, or FreshBooks can help automate record retention. Businesses making recurring payments should reconcile bank statements, payroll reports, and tax filings quarterly to catch inconsistencies before they become compliance problems.

Reporting Considerations for Both Parties

Both businesses and independent contractors have tax reporting obligations. Companies must correctly file Form 1099-NEC, while contractors must report their earnings and pay any required taxes. The IRS cross-checks 1099 filings with individual tax returns, so accuracy is important to avoid triggering an audit.

For businesses, compliance involves more than just issuing the 1099-NEC. Payments must be properly categorized in financial records, and any backup withholding must be deposited with the IRS using Form 945. If a contractor does not provide a valid TIN, businesses must document their withholding efforts. If the IRS determines a worker was misclassified, the company may owe payroll taxes, Social Security, and Medicare contributions, along with penalties.

Independent contractors, including undocumented workers using an ITIN, must report all income on their tax returns. They may also need to make quarterly estimated tax payments using Form 1040-ES to avoid underpayment penalties. The self-employment tax rate, which covers Social Security and Medicare, is 15.3% as of 2024. Contractors can deduct business expenses like equipment, supplies, and home office costs to lower their taxable income, but they must keep proper records in case of an audit.