Tag Archive for: W-2

California CPAs should ask their clients who hire 1099s if they have a contractual agreement, invoices, licenses, insurance, and an EIN.

Certified Public Accountants (CPAs) have the most insight into their business owner clients’ daily transactional history. You may find that your clients who have 1099 contractors are now in the grey area of worker classification since it was redefined by AB-5 in January 2020.  

Under the new bill, all workers are automatically classified as W-2 employees unless they meet all three of the following 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
  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.

We frequently see cases of inadvertent contractor misclassification that are flagged by The Employment Development Department (EDD). EDD audits are most commonly triggered by: 

  • Independent contractors filing for unemployment benefits 
  • Employee complaints 
  • Late tax filings 
  • Random verification audits 

If the agency finds any misclassified workers during the audit, it results in fines, fees, and penalties that can be damagingly high if left unaddressed. 

Keeping this in mind, here are questions you can ask your clients to ensure that their 1099s are correctly classified, and help your clients reduce the risk of an EDD Misclassification Audit: 

  • Do your 1099s do similar jobs to your W-2s?
  • Do you have a contractor agreement with all of your 1099s?
  • Do your contractors Invoice you?
  • Does your contractor have a license?
  • Do they have insurance? 
  • Do they have an EIN?

Here’s an overview of how each question can provide more insight for your clients. 

Do Your 1099s do Similar Jobs to Your W-2s?

1099 independent contractors who perform similar jobs as W-2 employees may be considered an employee during an audit unless there is a clear distinction between the two. Make sure there are clear distinctions between the two. The W-2 employee works regulated hours, has specific job functions, is provided work equipment, and is told when and how to perform their job duties. They also receive employee benefits and do not have a clear end date for the work performed. 

On the other hand, 1099 independent contractors have flexible working hours, flexible job requirements as dictated through the contract, must provide their own working equipment, can work for multiple employers at the same time, and are not directly managed on job functions. They do not receive employee benefits and have a clearer job end-date. 

For example, one of your business owner clients may have a marketing coordinator who is classified as an employee. Your client may want to hire a marketing agency for a website redesign as a 1099 independent contractor. While both the marketing coordinator and the marketing agency perform job functions under the marketing umbrella, their job functions and classifications are different. 

The coordinator develops and executes the client’s marketing strategy specifically for your client’s company for as long as they work in that specific role. The hired marketing agency will perform the website redesign for your client until the project is complete. Once finished, the partnership is completed. While the marketing agency is working on your client’s website redesign, they can simultaneously work for other companies. 

Do You Have a Contractor Agreement With all of Your 1099s?

The independent contractor agreement outlines specific details for the job the independent contractor will perform. It is the working arrangement between the client and the contractor that typically includes:

  • A description of the job or service provided by the contractor
  • Payment details (this can include information about retainers, deposits and billing) 
  • The length and term of the project or service 

Do Your Contractors Invoice You?

Invoices help keep records of payments, type of work performed, and hours worked. Having organized records of invoices between the contractor and the client helps EDD verify that the independent contractor is indeed an independent contractor. 

Clients who put 1099s on scheduled payroll put themselves at risk for a misclassification audit. W-2 workers should be placed on payroll, not 1099s. 

Does Your Contractor Have a License?

Some workers (such as healthcare professionals and construction workers) are required to provide proper licenses to work. Failing to hire workers with proper licensure can open your client’s business to hefty fines and penalties from EDD. 

If your client hires contractors who don’t have licenses do they have: 

  • A website?
  • A social media presence? 
  • A marketing budget?

These are all important factors to consider. 

Do They Have Insurance? 

Independent contractors provide their own insurance to cover liability, worker’s compensation, or other risks to help them protect their business. If your client is insuring their independent contractors, this is a sign they may actually be W-2 employees. 

Do They Have an EIN?

An EIN is an Employer Identification Number. This is a unique tax identification number for businesses in the United States to pay state and federal taxes. Asking independent contractors without an EIN to provide one is a simple way to further ensure they are 1099s.

All of these factors add up to a robust defense against a misclassification audit by EDD. By fixing any misclassification errors ahead of time, CPAs can save their business owner clients the hefty fines and penalties associated with EDD audit findings. Want to learn more about the EDD audit process? 

Read our article on what to expect in an EDD audit here. 

 

California CPA's should ask their clients the right questions to help them avoid triggering an EDD audit

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. 

Make sure you provide the list of employees, by wage category, including their wages and their job description with the corresponding code description.

We partnered with benchmark commercial insurance to discuss how audits relate to workers’ compensation. Benchmark offers a boutique approach to serving their clients through providing and maintaining commercial and personal insurance policies. Their goal is to establish comprehensive risk management and accident-avoidance programs to help prevent claims from arising. Get to know benchmark here

Watch our full video on how audits and workers’ compensation relate to one other in our video below.

 

 

How do Audits Relate to Workers’ Compensation?

Under a workers’ compensation policy, a policyholder is required to verify with the workers’ compensation carrier the actual wages that were paid to W-2 employees. In cases of hiring 1099 independent contractors, if they do not have workers’ compensation, the policyholder must verify the policy term. 

Most often, the audits triggered by workers’ compensation issues are referred to as wage verification protocol. The most important thing to remember about wage verification protocol when it comes to a workers’ compensation carrier, is making sure that you are providing the list of employees, by wage category, including their wages and their job description. In the provided list, make sure that each job description matches the code description in which you have them classified. 

During the process, your attorney should be reviewing the schedule with you before submitting the verification to the agent (auditor). Reviewing the schedule helps avoid having to reclassify wages in a higher-rated code post wage verification protocol. 

 

What is the wage verification protocol?

When the Employment Development Department (EDD) notifies business owners of the verification protocol, they send a letter in the mail. When business owners partner with our Milikowsky Tax Law team, we research the hired independent contractors that meet the criteria to be correctly classified as 1099 workers. In this process, we find:

  • Business reports 
  • Background reports 
  • Verify EAM and DBA
  • Business license 
  • EIN number
  • Social media accounts 
  • Website, if they have one (sometimes freelancers use Fiverr or Yelp pages instead)

Sometimes, during the verification process, EDD will notify business owners that workers were misclassified as independent contractors and should actually be classified as full-time W-2 employees. All of the information we gather on each individual worker helps build a case with EDD that the hired 1099 independent contractor is properly classified as such. 

The writeup we create for each worker is included in our initial response to EDD. When the auditor receives it, they don’t have to pursue the same research we already completed. While they will still need to verify our findings, the auditor will not have to develop their own theory about classification because we’ve already given them the story and the answer. This process is easier for the auditor to see versus when they are given information without a story behind it. 

There are tips and tricks to help business owners avoid feeling blindsided through the audit process either by EDD, CSLB, or by their workers’ compensation carrier. We’re here to help before business owners ever get to that process. Learn more about What to Expect in an EDD Audit here.

 

We partnered with benchmark commercial insurance to discuss how audits relate to workers’ compensation.

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

 

contractors files

In January 2020 California AB-5 will go into effect and many workers previously classified as contractors will be required to reclassify as W-2 wage earning employees.  The CA EDD has always had criteria by which employers can determine whether a worker is classified correctly as a 1099 but those criteria were more numerous and open to interpretation.  Now, starting in January 2020, there are only 3 criteria and a 1099 contractor must meet all 3 parameters or else they must be classified as W-2 wage earning employees. For those companies who are exempt (doctors, dentists, lawyers, architects, insurance agents, accountants, engineers, financial advisers, real estate agents, and hairstylists to name a few) from the new AB-5 criteria, the 13 point Borello test is still the standard by which contractor status will be determined.

The 13 point Borello test and new “ABC’s” test are not dissimilar, see infographic below to see how the Borello criteria relate to the new ABCs of worker classification.

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If you have questions a round the new AB-5 law and how your workers will be viewed by CA EDD, reach out to the team at Milikowsky Tax Law.  We are experts in California Employment Law and can guide you through the process of reassessing your company’s workers and their classification.