Tag Archive for: 1099 independent contractors

Independent Contractor

New classification guidelines between W-2 employees and 1099 independent contractors place stricter rules for businesses looking to hire. Common misconceptions about independent contractors can lead to businesses misclassifying workers and paying high penalties and fines. Avoid these consequences by understanding the regulations your business must follow when hiring independent contractors.

Let’s discuss the common misconceptions small businesses have about independent contractors. 

What is an Independent Contractor? 

A 1099 independent contractor is a worker who provides skills and services outside of the hiring entity’s usual course of business. They maintain control of their own work and performance, such as: 

  • Deciding when and where they work
  • Setting their own rates
  • Supporting multiple clients
  • Providing their own tools 
  • And more

How Do You Classify an Independent Contractor?

Worker classification regulations are now stricter due to Assembly Bill 5 (AB-5). This new law took effect in January of 2020 and changed how Small Business Owners (SBOs) who hire Independent Contractors operate in California.  

AB-5 introduced the ABC test as a stricter guideline to determine how to classify a worker as a 1099 independent contractor. The worker must meet all three criteria of the ABC test in order to be classified as a 1099 independent contractor instead of a W-2 employee.

  1. The worker is free from the control and direction of the hiring entity in connection to the performance of the work.
  2. The worker performs work that is outside the usual course of the hiring entity’s business.
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

If the contractor misses even one of the criteria in the ABC test, he or she is automatically classified as a W-2 employee. 

Learn more about how this law came into effect, and how Dyanmex ruined it for everyone, here. 

What is the Difference Between a W-2 Employee and a 1099 Independent Contractor?

1099 Independent Contractors

1099 workers have their own independent businesses which the hiring entity maintains little control over – especially regarding daily operations. The hiring entity will not be responsible for withholding taxes from the independent contractor’s paycheck or for providing benefits (i.e. paid time off, medical benefits, and more) to the worker. 

Instead, the worker will usually be paid hourly on a project-to-project basis. The 1099 independent contractor will also often bring their own equipment and supplies to carry out the service. 

W-2 Employees

W-2 employees will be paid on a regular basis, often have a salary instead of hourly income, and may be given certain benefits such as healthcare and vacation pay. The hiring entity is responsible for filling out and filing with state and federal agencies, such as unemployment insurance, worker’s compensation, Medicare and Social Security forms. 

Additionally, the hiring entity is responsible for taking Social Security tax, Medicare and state and federal taxes from the employee’s paycheck as well as supplying any equipment necessary for the employee to perform the service. 

What Are Common Misconceptions About Independent Contractors?

With the addition of stricter guidelines surrounding the classification of W-2 employees and 1099 independent contractors, misconceptions about independent contractors are increasingly prevalent and can often lead to costly mistakes, such as misclassifying a worker. 

1. Hiring Workers as Independent Contractors is Less Expensive than Hiring Them as Employees.

While small businesses may save money on payroll taxes and benefits, hiring an independent contractor on a long-term basis may carry the opposite financial effect.

For example, the lack of control over daily operations and the inability to train workers can hinder the efficiency of the service being performed. These hindrances can lead to the service taking longer, increasing the number of billed hours at which the workers are often paid a higher hourly rate, and result in a higher final cost than if a W-2 employee had provided the service.

2. If the Worker Performs Similar Work for Other Businesses, They Are an Independent Contractor. 

The service performed by the worker is not a determining factor in their classification as a W-2 employee or 1099 independent contractor. 

Instead, the working relationship your company has with this worker, in relation to AB-5 law and the ABC test, will determine their status as an independent contractor. 

3. You Can Hire a Worker as an Independent Contractor on a Trial Basis Before Hiring Them as a W-2 Employee. 

The tradition of hiring a 1099 worker, observing their performance, and switching them over to a W-2 employee after a set trial period is common practice amongst businesses wishing to try out new hires or services. This practice, however, often pushes against the regulations set out by the AB-5 law. 

The working relationship between the new employee and the company during the trial period must be examined in determining their status as an independent contractor.

4. Your Company Can Sign a Written Contract to Make the Worker an Independent Contractor.

A written contract does not necessarily depict an accurate representation of the working relationship between worker and employer. 

The working arrangement must be consistent with the regulations of AB-5 law and the ABC Test for the worker to be classified as an independent contractor, regardless if there is or is not a written contract in place. Further, a contract is not enough to protect the employer from liability for misclassification if the working relationship does not meet the legal requirements for independent contractor status. 

5. Your Worker has a License so They Must be an Independent Contractor. 

Similar to having a contract in place, any licenses the worker has are not enough to determine their classification as an independent contractor. Their status will be determined by a number of factors outlined by AB-5 law and the ABC test.

How Do I Avoid Misclassification?

You can avoid misclassification by carefully analyzing the arrangement you have with your worker in relation to the guidelines described in the ABC test and regulations set forth by AB-5 law.

To learn more, read on about how to hire an independent contractor. 

Dynamex, AB-5 and Prop 22 explained

Who is Dynamex and what did they do?

Watch our video below:

 

Dynamex was a nationwide same-day delivery and courier service. They employed their California drivers as W-2 employees who received the benefits, payroll taxes, and perks of being a W-2 employee. However, in 2004, the company reclassified all of its California drivers into 1099 independent contractors to save employee costs. 

 

With reclassified 1099 independent contractors, Dynamex then avoided paying their portion of employee payroll taxes, medical benefit costs, or other employee benefits costs. It saved them money at the expense of their workforce.   

 

After their reclassification, an employee filed a lawsuit against Dynamex for misclassifying him as an independent contractor and stripping him of his employee benefits. This lawsuit turned into a supreme court ruling that ultimately led to a completely new and stricter reclassification system than what was set in place before. 

 

The California Division of Labor stated that the Dynamex case misclassifications alone cost the state $7 billion each year. 

How did AB-5 come to be? 

The Supreme Court ruling on the Dynamex Operations West, Inc. v. Superior Court on April 30, 2018 changed the regulations for employers to classify workers. Before the ruling, worker classification was based on the unclear 13 Factor Borello Test. As a result of the ruling, the court created the California Assembly Bill 5 (AB-5) that included the new and clearer ABC test for employers to correctly classify workers.

 

AB-5 was signed into law by California Governor, Gavin Newsom, in September of 2019 and went into effect January 1, 2020. This is not just another bill. The new AB-5 law directly affects the way Small Business Owners (SBOs) who hire Independent Contractors will operate in California. The law impacts ALL SBOs. 

 

This new law redefines the way you as a business owner must classify your workers. It will now push California business owners to employ workers as W-2 employees and pay for benefits and protections (unemployment, overtime, sick leave, and worker’s comp) that employees get under California Law. 

 

There are several exceptions for specific industries and job categories. For those industries, the worker classification guidelines under Borello remain the standard by which EDD will determine worker classification. 

 

As of January 2020, California Employment Development Department (EDD) places the burden of proof on business to show that workers are correctly classified as 1099 contractors and that they should not be reclassified as employees under the stricter criteria set out in the new law. 

 

The new AB-5 law raises standards for many California workers to determine worker classification.

What is the ABC Test? 

The ABC test is AB-5’s new guideline for how to properly classify workers. In order to classify a worker as a 1099 independent contractor instead of as a W-2 employee,  they must meet all three criteria

 

  1. 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;
  2. The worker performs work that is outside the usual course of the hiring entity’s business; and
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

 

What is the Borello Test? 

The 13 Factor Borello Test was the first method to classify workers. While the ABC test is now the new regulation and standard for worker classification, the Borello Test is still used today. Employers hiring exempt employees can fall back on this test to classify workers. The test asks the following 13 questions. 

 

  1. Do you instruct or supervise the person while he or she is working? 
  2. Can the worker quit or be discharged (fired) at any time?
  3. Is the work being performed part of your regular business?
  4. Does the worker have a separately established business?
  5. Is the worker free to make business decisions that affect his or her ability to profit from the work?
  6. Does the individual have a substantial investment in their job which would subject him or her to the financial risk of loss?
  7. Do you have employees who do the same type of work?
  8. Do you furnish the tools, equipment, or supplies used to perform the work?
  9. Is the work considered unskilled or semi-skilled labor?
  10. Do you provide training for the worker?
  11. Is the worker paid a fixed salary, an hourly wage, or based on a piece-rate basis?
  12. Did the worker previously perform the same or similar services for you as an employee?
  13. Does the worker believe that he or she is an employee?

 

Who Benefits from AB-5?

Beneficiaries of the stricter classifications are:

 

  • Workers in the gig economy who want to be able to unionize
  • Those working full time without benefits and who will, under AB-5 have to be offered benefits, protections, and earnings guarantees.

 

An example of a beneficiary of the new law might be 1099 workers for a large cleaning company who work fewer than 40 hours but only for one company, and do not have the benefits or protections of being an employee. These workers would, under the new law, be classified as employees and would be offered benefits, unemployment insurance and protection under the labor laws from being fired without just cause among many other W-2 wage-earning employee benefits. 

Who is at a disadvantage with AB-5? 

Companies who will find that AB-5 puts them at the biggest disadvantage in this new classification system are small to mid-sized business owners who want a flexible workforce by employing workers to help when times are good and then scale back either seasonally or due to market conditions. 

 

These small business owners will have to pass a much stricter analysis in order to be able to hire 1099 workers as opposed to W-2 employees. The burden of proof lies with the employer to prove that a worker is correctly classified as a 1099 contractor. and EDD will request proof that 1099 contractors have a legitimate business starting in January 2020.

 

Another group that may find the new law puts them at a disadvantage is the independent contractor who prefers to remain a 1099 contractor. According to Forbes and Gallup, 36% of US workers are in the Gig Economy. 

 

Retired people choose to pick up work, just like many recent grads and stay-at-home parents. For most of these workers, they don’t mind a 1099 contractor status and they do not want to be managed as a W-2 wage earner. For those workers, these new AB-5 classification rules are not offering any tangible benefits, they are creating impediments. 

 

Surveys done by Intuit in 2016, found more than 90% of contract workers prefer the flexibility and personal control they have as independent contractors. They can accept or reject a job based on the amount offered, timing, or indeed any reason – these workers work only when they want. 

What does this mean for Uber, Lyft, and other Rideshare programs? 

Uber, Lyft, and HopSkipDrive drivers may have to choose one “employer” and thereby not be able to pick up as much work in a given period of time. The ramifications of this shift will certainly affect both companies and workers. 

 

In order to find a solution to converting rideshare workers into employees, and keep them as independent contractors, Prop 22 was created. This piece of legislation sought to sidestep AB-5 regulations so that rideshare workers can remain independent contractors instead of becoming W-2 employees. 

 

Thus, they remain eligible to work when and how they want, and for as many rideshare app companies as they wish. Learn more about what Prop 22 means for you in our article here. 

Dynamex turned their W-2 employees into 1099 independent contractors. This stripped wither workers of their benefits and caused the Supreme Court to create AB-5

 

Business owners should be aware of the common mistakes when hiring and working with 1099 independent contractors

Business owners hire independent contractors to help with specialized or contracted work. But, as a business owner, if you find yourself engaging in what may be considered an ‘employer-employee relationship’ with your independent contractor hires, you may be contacted by the Employment Development Department (EDD) and/or the Internal Revenue Service (IRS) for a potential misclassification audit.

Misclassification is one of the reasons EDD may conduct an audit of your business. These audits might result in:

  • Penalties
  • Fees
  • Back taxes owed
  • Potential criminal liability.

How Do You Know if You Should Hire Someone as a W-2 Worker or a 1099 Independent Contractor?

Choosing to hire a worker as either a W-2 worker or a 1099 independent contractor requires knowing the criteria for classification and how the worker’s services dovetail with your current company offerings. When you consider the correct worker classification, consider who holds the right of control. The right of control looks at these three criteria to aid in determining classification:

 

  • Behavioral Control: Are you in charge of the manner in which workers perform their duties?
  • Financial Control: Do you pay regular wages and have the ability to fire the employee?
  • Relationship to business: Is the employee an essential part of helping your business run?

 

A W-2 worker is someone hired for a specific job, is given set work hours, receives benefits, works for one specific employer, and has taxes deducted from payroll.

1099 independent contractors, on the other hand, are hired on a contractual basis for a specific task, are paid a set fee, do not receive benefits, do not have taxes deducted from payroll, and have more work flexibility overall. 1099 independent contractors can work for multiple employers simultaneously.

For example, an administrative assistant hired as a W-2 would show up during regular set work hours and complete set tasks for the job in their scope of work. They receive benefits, are taxed on payroll, and report to a higher authority.

An administrative assistant hired as a 1099 would have his or her own business entity, set their own scope of work, invoice the company for work performed, and would work for other employers simultaneously. Once the scope of work is completed, they no longer work for the company.

Before hiring someone as a W-2 or a 1099, make sure they fit the new strict Assembly Bill 5 (AB-5) classification requirements to avoid triggering a government audit of your business.

What is AB-5?

AB-5 is a California law put into effect January 1, 2020 that changed previous worker classifications. Before AB-5, EDD classified employees through the Borello test. This test had looser, less clear requirements for classification. Now, the agency set forth clearer rules and regulations, called the ABC test, regarding classification between W-2s and 1099s.

What Are the ABCs of Contractor Classification?

The ABC test under California’s AB-5 regulation explains that all workers are considered W-2 employees who receive benefits and payroll taxes unless all three of the following criteria are met:

  • “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.”

 

Why Does the Government Care about Correct Worker Classification?

When workers are misclassified, the government does not receive the correct payroll taxes. Incorrectly classifying W-2 employees as 1099 independent contractors also strips the worker of benefits they would receive as W-2 employees.

Companies who incorrectly classify employees as contractors save money in workers’ compensation, payroll taxes, paid time off, benefits, and retirement accounts.  Because of these savings, they may be able to undercut the competition at the sacrifice of their workers.

Businesses who adhere to the W-2 classification criteria might report other companies for this kind of misclassification because it creates an unfair playing field for businesses who adhere to regulations.

Not every business that uses 1099 contractors is predatory or wrong in their classification. Many businesses use 1099 contractors correctly. When working with independent contractors, there are a few pitfalls to be aware of so you don’t accidentally treat your independent contractors like your employees.

 

Common Mistakes When Working with Independent Contractors 

Here are a few behavior scenarios that could lead to potential issues when working with independent contractors:

1. Not Renewing Scope of Work

Contractors are normally hired to work on a per-job or project basis. They submit a Scope of Work with clear Key Performance Indicators (KPIs) and report on the hiring entity’s Return on Investment (ROI).

Even if the relationship lasts years, the 1099 worker or outsourced company will invoice the business using their services and maintain a contract and billing records. 1099s also have tax records to show that they pay their own income taxes on the money paid to them by the hiring entity.

 

2. Dictating the Use of Equipment or Software

Contractors determine the tools and equipment to use for their job. A contractor who provides a service that requires the use of your internal software is not automatically a W-2. It is important to be clear in the proposal that they will provide their own schedule, deliverables and likely will use other software to service other clients.

 

3. Setting a Schedule for Contractors

While contractors can be required to be on calls at set times, you cannot suggest or direct when a contractor takes breaks or even what time of day they need to start work.

By establishing a schedule for your contractor outside of assignment deadlines and scheduled agreed-upon calls, you could be seen as engaging in an employer-employee relationship.

 

4. Making Contractors Work in the Office

If contractors are working in your offices or place of business, this may cause some labeling issues when determining if they are a contractor or an employee. If a contractor is working out of an office alongside full-time or part-time employees, they might be confused or misclassified as an employee, especially if they are working similar hours and performing similar tasks.

 

5. Paying Wages and Expenses Incorrectly

Salary or hourly wages are reflective of employee behavior. To avoid any confusion, it’s best practice to pay contractors by project or retainer. Contractors pay for their own resources and supplies. While they may work in your CRM (in the case of an outsourced marketing agency), they will have their own project management software to manage their internal workflows.)

 

6. Requiring the Contractor to Only Work with Your Business

Unlike W-2 employees, independent contractors have the flexibility to work with multiple employers at once. At any given time, they may choose to only take on your business alone, but this is at their discretion. If they choose to work with seven different businesses at once, they have the right to do so.

By asking them to sign a non-compete agreement, you treat them as an employee rather than a contractor. This means they must receive the benefits that employees receive. Instead, your business can communicate with the independent contractor about a confidentiality agreement to keep your business’s information secure. 

 

7. Not Verifying Contractor Status

In order for an independent contractor to be properly licensed and classified, they should have the following criteria: 

  • Verified website or social media accounts 
  • Client base 
  • EIN number 
  • Business license

If they are missing any criteria, the best practice is to communicate with the contractor so they can provide any missing information. 

 

What Triggers EDD Audits?

Although the government agency performs random misclassification audits of businesses, they do audit businesses when they are flagged. Triggering an EDD audit can come in many forms, but they all have the same outcome – an audit of your business.

Be aware of the top four EDD audit triggers to help your business steer clear of an audit. Remember there isn’t a foolproof plan to avoid an audit, but staying away from the common triggers can help set your business up for success. 

  1. Having an independent contractor who files for unemployment
  2. Employee complaints
  3. Filing your business taxes late
  4. Randomized verification audits

Read on for more about why each instance triggers an audit and how you can prepare.

The Employment Development Department is meticulous with the audit process and takes misclassifications seriously. Misclassifying even one worker can trigger an EDD audit of your business. These audits are serious and can result in fines and penalties of thousands, if not hundreds of thousands of dollars.

If your business is undergoing an EDD audit, learn more about what to expect in an EDD audit here.

 

 

business owners should avoid key mistakes when hiring and working with independent contractors