Payroll Worker Classification
W-2 versus 1099?
One of the most common questions we get about payroll management for independent contractors is when to classify your contract workers as W-2 versus 1099. The answer comes down to accurate worker classification.
That said, there is no black and white answer. So how does a company ensure they get it right, when “right” is open to interpretation?
It’s a question we take very seriously. Our proprietary classification tool, IC Advisor, uses artificial intelligence to comb through thousands of case law rulings to determine the level of risk associated with classifying a worker as an independent contractor. We do this for each and every worker to confirm decisions are compliant.
We adapt to all regulations to:
- Keep up with the ever-shifting legal landscape of hiring contract professionals
- Make it safe to hire freelancers and temporary workers
- Absorb the risks involved with hiring independent contractors
Is Your Independent Contractor Really Independent?
This is a deceptively complex question that’s important to answer “yes” because the risk of your company facing an IRS or DOL audit has never been greater.
Independent Contractors (ICs) are self-employed, hired to do a specific job, and receive payment only for the work performed. Unlike a regular employee, they pick their jobs and regularly move from client to client, business to business. Also referred to as freelancers, consultants, and “1099’s,” they report the payments received as business income and pay self-employment taxes.
Hiring an independent contractor is attractive to those companies looking for outside creative resources, and who want to outsource work that is not central to their main line of business. The work is project-oriented and is typically completed in a short amount of time. And, you are better able to meet budget by paying your IC as a vendor, not as an employee.
But there’s a big catch.
The IRS has very strict guidelines that define true business-to-business relationships and payroll compliance. These guidelines are meant to prevent firms from misclassifying would-be employees and thereby avoid, either knowingly or unknowingly, a bounty of state and federal taxes.
Key things to require when working with an Independent Contractor
- Your contractor has an established business entity, with a business name and EIN to which invoice payment is made
- Your contractor provides services to other businesses outside your firm
- Your contractor provides certificates of insurance, including at the least, coverage for general liability insurance and workers’ comp insurance
- Absorb the risks involved with hiring independent contractors
- You have a signed per project Agreement for Services between your company and the contractor
Assembly Bill 5 and California Worker Classification
Accuracy is especially important when it comes to California’s worker classification rules. The state’s Assembly Bill 5 (AB5) approved codifying the ruling in the Dynamex Decision, which uses a strict ABC rule to determine whether a worker is an independent contractor or an employee.
This ABC test says a worker can now be considered an independent contractor only if all of the following apply:
- A: 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;
- B: the worker performs work that is outside the usual course of the hiring entity’s business; and
- C: the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
What does Assembly Bill 5 mean for your business?
As California’s guidelines get stricter, many other states are following suit. This trend, along with rapid growth of the independent workforce, means increased scrutiny by the IRS and state labor agencies to make sure workers are appropriately classified. Misclassifying workers as independent contractors presents a huge risk for any enterprise.
The result? It’s next to impossible to classify workers as independent contractors.
The California law is complicated, but it doesn’t have to be a problem. With the right attention and forethought, PayReel and businesses can navigate the landscape with relative ease.
Worker Classification Best Practices
Accurate worker classification, in our world, is a must. With rapid growth of the independent workforce we’ve seen a dramatic increase in scrutiny by the IRS and state labor agencies to ensure workers are appropriately classified. Misclassifying workers as independent contractors presents a huge risk for any enterprise.
PayReel will help ensure that all your freelance contractors are properly classified by vetting the work, the worker’s role, evaluating the risk and making a classification decision.
