Millions of American businesses hire independent contractors to perform all types of services. And millions of American workers prefer to work as contractors rather than employees.
Due to the COVID-19 pandemic, more people than ever want the freedom that comes with being an independent contractor.
But for decades, many state and federal agencies have had it in for businesses that hire independent contractors rather than employees. They prefer that you classify your workers as employees because then you must:
- pay unemployment insurance premiums
- provide workers’ comp
- withhold taxes from employee pay
Employees are also protected by state and federal labor laws that regulate worker rights, such as a minimum wage, overtime, and the right to unionize.
In 2020, California launched the broadest assault on independent contractors in recent memory when it passed a law popularly known as AB-5. This established an incredibly strict new “ABC test” for determining whether California workers should be classified as employees for purposes of California law. Many feared this would spell the end of independent contractors in California.
It hasn’t worked out that way. The California legislature received a firestorm of complaints from California-based independent contractors and the firms that hire them. As a result, it significantly watered down the new law by providing over 100 exemptions to the ABC test. Meanwhile, California voters responded by passing Proposition 22, which completely exempted most drivers for app-based rideshare and delivery platforms such as Uber, Lyft, and DoorDash.
This outcome appears to have dampened the appetite of many other state legislators seeking to make it harder to hire independent contractors.
The Biden administration wants to take up where California left off. It supports the adoption of the ABC test across all federal laws. This is not likely to happen anytime soon.
The IRS, in its efforts to make 1099 independent contractors W-2 employees, relied for years on a 20-factor test. This test proved cumbersome, and today the IRS has broken the 20 factors into three broad factors:
- Behavioral control – An individual looks more like an employee if the company they work for has significant control over the day-to-day details of their work (e.g., specific contractual/contracted instructions or supervisor oversight). On the other hand, if an individual decides primarily how they perform their work, they look more like an independent contractor.
- Financial control – An individual looks more like an independent contractor if they have invested significantly in their business, have unreimbursed expenses, and run the possibility of incurring a loss.
- Type of relationship – An individual looks more like an employee if they work exclusively for the company; plan to work there indefinitely; and get benefits such as a retirement plan, sick days, and medical benefits.
Employers who misclassify employees as independent contractors to reduce labor costs and gain an advantage over competitors can end up paying large back taxes, fines, and judgments.
It is important that both the company and the independent contractor understand exactly what they are agreeing to. I have seen many instances where independent contractors were shocked when it came time to file their taxes––often owing hundreds or thousands of dollars they were not expecting.
Contact Us To Learn More About The Taxes Associated With Hiring Independent Contractors
If you have questions about tax laws and hiring independent contractors, please contact The Youngblood Group, LLC today. You can schedule an appointment to learn more.