Contingent workers—including freelancers, independent professionals, temporary contract workers, independent contractors and consultants—are in high demand. But are your workers really contingent or are you bending the rules in a way the U.S. Internal Revenue Service (IRS) or the workforce commission might crack down on?
Treating contingent workers as independent contractors (using 1099s) when they should be employees is called employee misclassification. It is a serious issue because, according to the National Conference of State Legislatures, it can result in millions of lost tax dollars for state and federal governments. It’s also a labor rights issue since contingent employees misclassified as independent often work without the legal protections typically afforded employees, such as wage and hour laws, workers compensation and unemployment benefits.
The U.S. Department of Labor (DOL) and the IRS have joined forces with at least 32 U.S. states to combat employee misclassification and to ensure workers get the wages, benefits and protections to which they are entitled. And workers are getting the message. Large companies like Pacific Gas & Electric Co. (PG&E) in California have been hit by lawsuits claiming they’ve wrongly classified contingent employees as independent contractors. Typically in these situations, employers are left to pay large amounts of uncollected Social Security and Medicare taxes. One DOL report claims employee misclassification affects nearly 40 percent of all Texas construction workers. Department of Labor Wage and Hour Division (WHD) Administrator David Weil adds misclassification is “a problem that has spread to a lot of other industries,” including janitorial and ride-sharing services.
As we’ve pointed out before, in order to classify a contingent worker as an independent contractor, the position must fulfill a 20-point test to prove the employer is restricted in the amount of behavior, financial and other relational control it has over the worker. These points can be found in full on the Texas Workforce Commission’s website but, to summarize:
- You cannot control when, where or how an independent contractor performs the services they’ve been hired to perform. A gigantic red flag for the IRS is whether a contractor is required to work at a particular location or office, on special equipment provided by the employer and/or with specific training provided by the employer.
- Independent contractors aren’t reimbursed for expenses as often as employees are. Also, contractors will usually provide invoices and charge flat or project fees, as opposed to expecting hourly, weekly or monthly wages. Contractors also incur their own expenses and cost of doing business, including marketing and advertising expenses.
- Written contracts, letters of agreement and invoices all give clues as to how “permanent” and “controlling” the relationship may be. Certainly promising an independent contractor employee-type benefits such as insurance or vacation pay is an indication the individual is misclassified. A more subtle sign would be the lack of a contract that terminates (or can be renewed) on a specific date, indicating you intend to work with the individual indefinitely, much like an employee.
If your relationship with certain contingent workers violates any of these rules, you do still have an alternative to permanent employment. That alternative is using a staffing firm. Reputable staffing firms hire temps and temp-to-hire workers, offering them the benefits of full-time employment. It can provide the flexibility of using independent contractors without the administrative burden of putting the workers on your payroll. A staffing firm can share—and even take on most—of the employment responsibility, with the exception of a few co-employment liabilities (which we outline in our guide, New Rules of Co-Employment).
Have any questions about contingent workers and employee misclassification? Let us know! We’ll be covering the topic in more depth in an upcoming resource guide.
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