The State of the Self-Employed survey, conducted by Intuit’s QuickBooks just before the start of the pandemic, found that nearly 30% of the nation’s workers–or 44 million people–were self-employed at some point during 2019. Meanwhile, 14% of workers said being an independent contractor was their primary job.
With this many people identifying as self-employed, it’s no wonder the federal government is reviewing regulations to determine a federal standard. The problem is that identifying an independent contractor, sometimes known as a 1099 worker, can be a confusing compliance challenge for employers. It is important that employers correctly identify a worker as either an employee or independent contractor, as the financial penalties for misclassification can create an undue hardship on the employer as well as deny workers rights they may be due as employees.
Through both federal and state government agencies, an employee may be guaranteed many rights and protections including minimum wage and overtime payment, unemployment insurance, a safe workplace, health benefits, family and medical leave, and payment of federal and state taxes.
Alternatively, independent contractors are not guaranteed such rights and they are responsible for the payment of certain taxes. If misclassified and determined to be an employee, the worker could also be liable for tax payments that were not made on their behalf by an employer. If the misclassification was the result of the employer and not the worker, the employer could be liable for those taxes as well, according to the Internal Revenue Service.
Complicating matters further, technology is creating new industries, specifically what is now considered “gig” opportunities, i.e. Doordash, Uber and Lyft. These uncharted territories can cause disruption between the workers and the companies as each vie for a different classification for the allotted benefits.
Tests to Aid Employers
So, what’s an employer to do? Currently, three tests exist that can help employers determine independent contractor status.
For purposes of wages, the Department of Labor under the Fair Labor Standards Act currently defines an employee as “an individual employed by an employer” and employed is defined as “permitted or suffered to work.” It uses what is known as the “economic reality test” to make a status determination.
For purposes of payroll taxes, alternatively, the IRS uses the common-law rule that states “anyone who performs services for you is your employee if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.”
Another test, termed the “ABC test,” is used (or some combination thereof) by many states in addition to the common-law test. The ABC test, which also looks at direction and control, then evaluates if the worker engages in a trade, business or occupation similar to what he or she is doing for an establishment.
Additionally, states including California, Iowa, Louisiana, Virginia and municipalities like Minneapolis have passed their own legislation to establish a test for independent contractors; define who is an independent contractor; add protections for independent contractors; define an employee; and/or impose penalties for misclassification.
Under the Trump administration, the DOL adopted the Independent Contractor Status Under the Fair Labor Standards Act, known as the Independent Contractor Rule, which became effective March 8, 2021. But President Biden’s DOL already has announced plans to rescind the rule and withdrawn two opinion letters addressing independent contractors in food distribution and trucking.
That means employers should not rely on either the Independent Contractor Rule or the opinions published in these rescinded opinion letters as resources for determining independent contractor status.
Currently the DOL, the IRS and states impose penalties for misclassification of employees as independent contractors. Penalties that can be assessed include payment of required tax deduction including penalties that could go back for three years, failure to meet the applicable reporting requirements and the employee’s portion of tax deduction. Intentional misclassifications could mean criminal penalties and up to a year in jail.
Under President Biden, experts anticipate a focus on audits and an increase in enforcement penalties for misclassification of employees as independent contractors.
With a commitment to “aggressively pursue employers who violate labor laws, participate in wage theft, or cheat on their taxes by intentionally misclassifying employees as independent contractors,” the Biden administration has pledged to not hold back on fining employers. Therefore, employers should revisit their independent contractor arrangements and ensure that workers are properly classified.
With all this confusion, even well-meaning employers can inadvertently misclassify their workers. It is best for an employer to seek the advice of an HR expert or an employment attorney for assistance in deciding whether someone is an independent contractor or employee before a worker files a complaint or an audit is conducted by a government agency. Once the door is open to an audit, a business may have multiple agencies at its doorstep.