1099 Independent Contractors vs. W-2 Workers
Business considerations for managing your contingent workforce:
Nearly every business has a contingent workforce. In fact, in May 2017, there were 5.9 million contingent workers in the U.S., representing 3.8% of the U.S. workforce. Statistics here are a little fuzzy as these numbers are contested as severely understating the number. The BLS has not issued updated numbers simply states that the report is being looked at. While the statistics are fuzzy, the financial implications around misclassification are not. There can be severe financial repercussions to mishandling this part of your employee base.
Uber made headlines over a class action lawsuit in 2015. Unfortunately, other headlines follow. Now in their wake, Amazon, Google, and Lyft are seeing similar issues.
Don't think this problem is isolated to large companies. They make the news and have deeper pockets from which to fight. Worker misclassification is prevalent in Silicon Valley and the Bay Area. What most of these companies who "risk" being audited fail to realize is that one audit often turns into many, and the fines are hefty.
Many Silicon Valley start-ups and small businesses without strong HR policies believe that they can hire workers on a 1099 basis to fulfill temporary projects by merely using an IC agreement. A signed IC agreement may not be enough to protect you from legal trouble. www.independentcontractorcompliance.com discusses in a blog a massive case in which FedEx Ground lost because of its misplaced reliance on an IC agreement and its policies and procedures that were good, but not good enough. "IC agreements and policies and procedures that are not drafted in a state-of-the-art manner, free from language that can be used against the company, can cause businesses that use ICs to face class action litigation or regulatory audits or enforcement proceedings they may be able to avoid otherwise."
If you find yourself considering this work arrangement, research if the role meets the criteria using these tips to navigate proper classification.
January 1, 2020, Labor Code Section 2750.3 went into effect. The statute changes the test used to determine whether workers in California are employees or independent contractors. Section 2750.3 presumes that all workers are employees unless the hiring business can prove otherwise. It adopts the ABC test.
Under the ABC test, a worker is considered an employee and not an independent contractor, unless the hiring entity satisfies all three of the following conditions:
- The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;
- The worker performs work that is outside the usual course of the hiring entity's business; and
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
The law has expanded reach, including the California Labor Code, the Unemployment Insurance Code, and the Industrial Welfare Commission's Wage Orders. Certain occupations and industries are exempt and can use the Borrello test. Here is an excerpt from the Labor and Workforce Development Agency FAQ.
Occupations where the Borello test applies instead of the ABC test under Labor Code section 2750.3:
- Certain licensed insurance agents and brokers
- Certain licensed physicians, surgeons, dentists, podiatrists, psychologists, or veterinarians
- Certain licensed attorneys, architects, engineers, private investigators, and accountants
- Certain registered securities broker-dealers or investment advisers or their agents and representatives
- Certain direct salespersons
- Certain licensed commercial fishermen (only through December 31, 2022, unless extended by the Legislature)
- Certain newspaper distributors or carriers (only through December 31, 2020, unless extended by the Legislature)
This is not exhaustive, and you should consult a Labor Law Attorney.
The risks of working with 1099 independent contractors:
- Most likely, audits will be executed by the IRS, but other government agencies may get involved as well (Workers Compensation or the U.S. Department of Labor) among others.
- Class action lawsuits. A 1099 independent contractor may claim they were an actual employee and take legal action. This could result in a winning lawsuit regarding insurance, disability, benefits of varying kinds, and workers' compensation to name a few.
- This is a serious concern of the IRS and could result in thousands of dollars' worth of legal troubles, benefits, and back wages. Penalties of misclassification can be hefty and government agencies will seek all uncollected fees actively.
- Misclassification tax responsibility. The IRS may find you responsible for misclassifying an employee, and if that happens, you may be required to pay all withheld taxes (even if the contractor paid them individually) with interest.
Potential risks of hiring temporary workers instead of 1099 contractors:
Many firms decide to hire temporary employees via professional staffing firms instead of independent contractors. The adoption of 2750.3 will likely make this a much more appealing option. However, change is likely on the horizon in this area of employment too. On January 13, 2020, the U.S. Department of Labor announced a rule to update the regulations interpreting joint-employer status under the Fair Labor Standards Act (FLSA). It's been over 60 years since a change as significant as this has been made. Under the FLSA update, an employee may have one or more joint employers who are jointly liable for the employee's wages. There is a four-factor test to determine joint employers:
- Hires or fires the employee
- Supervises and controls the work schedule or conditions of employment to a substantive degree
- Determines the rate of pay and method of pay; and
- Maintains the employee's employment records
There can be other factors relevant to consider, which would also warrant the use of an employment lawyer. So in summary, non-employee utilization has been on the rise over the last 15 years. These changes to employment law may derail this trend but until then, it is clear that whatever the arrangement, temporary worker, or 1099, you should carefully consider weighing the risks and rewards of using contingent workers.