Misclassifying Your Employees: How the Latest Developments Could Affect Your Business
There have been countless headlines about worker classification in gig companies like Uber, Lyft and Instacart being questioned by courts all across the country. One such litigation escalated to California’s Supreme Court, and the ruling has made the limitations explicit and restricted by which employers can classify an employee as an independent contractor. As of April 30, 2018, California’s Supreme Court decision now upholds that courts should use the ABC test that other jurisdictions have used when evaluating whether or not a worker is an independent contractor (see Dynamex v. Superior Court). If you utilize 1099 contractors as a part of your business model, now would be a good time to reassess your practices to make sure that your classifications hold up to the latest legal requirements.
Although the headlines may have faded, the topic of misclassifying employees as “1099 Independent Contractors” still remains a hot topic for employers across the nation – and for good reason. Gig companies may be absorbing the brunt of lawsuits and legal scrutiny, but the reality is that many other organizations out there are operating under a risky misconception that classifying employees as 1099 contractors is above the law, as long as these contractors make their own schedule and receive a “high” hourly salary, among other factors. Frankly, it’s important to understand the laws surrounding and factors contributing to classifying workers correctly so that you do not fall into the same trap and face serious financial repercussions.
So what are the facts?
- Rise in Independent Contractor Audits – In response to increased employer taxes and workers’ desire for flexibility, the US has seen a huge jump in Independent Contracting; increased by almost 40%, going from 6.9% of employment in 2005 to 9.6% in 2015 – cited in HBR article “Lots of Employees Get Misclassified as Contractors. Here’s Why It Matters”. This spike has led to increased governmental audits, across all industries and company sizes.
- Crack Down on Unlawful Employers – A number of recent court cases have resulted in favorable outcomes for the employee, due to the state and federal government’s need to set a precedent and combat the fiscal uncertainty for the future.
- High Stakes – Misclassifying an employee as a 1099 independent contractor could deem an employer liable for unpaid employment taxes, back pay, overtime and meal break pay, employee benefits, disability payments, workers’ compensation, tax and insurance obligations, fines and other penalties from both the federal and state government.
- New Classification Test in CA – The Dynamex v. LA County case decision resulted in the adoption of a new, stricter test for independent contractor classifications in California known as the “ABC” test, effective April 30, 2018. Many states are following suit and passing similar laws which assume “presumptive employee status”, putting the onus on employers to prove their workers are not employees, as opposed to classifying independently.
So, how exactly do you assess if the individual you have working for you should be classified as an independent contractor or employee? For starters, you’ll want to analyze three key themes: control, compensation, and core function. There are many articles out there that help employers conduct this analysis, but we found Intuit’s online 1099 vs W2 Employee Calculator to be particularly helpful. Here’s a summary of the key factors that need to be considered:
1. Control: How much control do you exert over the worker?
If you exercise significant control over the way that their work is performed, for example, by requiring a specific schedule, providing training or supervision of their work, or by having them work on an ongoing, regular basis, the worker should probably be classified as a W2 employee. However, if they work on a project basis and can decide independently when and where they complete the work, then it is possible that they can be classified as a 1099 contractor. For example, if you have someone doing copywriting for your website who can set their own deadline and time when they will work on the project, then it’s probably OK to classify them as a 1099 contractor – as long as you do not require them to be available at specific times on a consistent basis to collaborate with your team, or to attend meetings.
2. Compensation: How do you pay the worker, and are they exclusively earning income from you?
If your worker is solely working for you and being paid on a similar cadence to your normal W2 employees and submitting hours via a timesheet, they should probably be classified as a W2 employee. On the other hand, if your worker is paid after submitting an invoice to you upon completion of a project or an agreed upon scope of work, then they are likely an independent contractor. An important factor that distinguishes independent contractors is that they typically are not solely reliant on one business for their livelihood – they operate as a business and typically perform work for a number of other clients or for the general public.
3. Core Function: Are the worker’s duties a core function of your business?
If the services being performed by your worker are essential to your business and contribute to your revenue, then they are probably a W2 employee. For example, if their absence would make running your day-to-day business difficult, like reception or customer service reps, then they are probably an employee. If, on the other hand, the services rendered are more specialized or a one-off, like a sales trainer, then they can probably fall under independent contractor status. Furthermore, independent contractors typically invest significant amounts of time or capital without any guarantee of success. If the individual’s performance of service establishes or affects his or her own business reputation, rather than your business’s reputation, then it is probably safe to assume that individual is an independent contractor.
The greatest takeaway from the latest decision by California’s Supreme Court is to assume that all workers are employees and that their W2 status can only be ruled out by using the ABC test as the ultimate guideline.