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.
- The worker is free from the control and direction of the hiring entity in connection to the performance of the work.
- The worker performs work that is outside the usual course of the hiring entity’s business.
- 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 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.