Employee Classification Compliance
In these uncertain times, employers must ask themselves whether or not they're complying with all of their legal requirements. The first question to ask is whether an individual working for an employer is correctly categorized as an W-2 employee or 1099 independent contractor. This can be a tricky minefield to navigate because different states and government departments categorize individuals differently. For example, in California, as of September 2019, the test that determines the employment status of an individual is the ABC test. The ABC defaults all working individuals as employees, unless the hiring entity meets all of the following conditions:
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;
The worker performs work that is outside the usual course of the hiring entity’s business; and
The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Other entities, such as the Internal Revenue Service (IRS), classify employees using a factor test. The IRS examines Behavioral Control, Financial Control and Relationship of the Parties.
Behavioral Control: A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised. Behavioral control categories are:
Type of instructions given, such as when and where to work, what tools to use or where to purchase supplies and services. Receiving the types of instructions in these examples may indicate a worker is an employee.
Degree of instruction, more detailed instructions may indicate that the worker is an employee. Less detailed instructions reflects less control, indicating that the worker is more likely an independent contractor.
Evaluation systems to measure the details of how the work is done points to an employee. Evaluation systems measuring just the end result point to either an independent contractor or an employee.
Training a worker on how to do the job -- or periodic or on-going training about procedures and methods -- is strong evidence that the worker is an employee. Independent contractors ordinarily use their own methods.
Financial Control: Does the business have a right to direct or control the financial and business aspects of the worker's job? Consider:
Significant investment in the equipment the worker uses in working for someone else.
Unreimbursed expenses, independent contractors are more likely to incur unreimbursed expenses than employees.
Opportunity for profit or loss is often an indicator of an independent contractor.
Services available to the market. Independent contractors are generally free to seek out business opportunities.
Method of payment. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time even when supplemented by a commission. However, independent contractors are most often paid for the job by a flat fee.
Relationship: The type of relationship depends upon how the worker and business perceive their interaction with one another. This includes:
Written contracts which describe the relationship the parties intend to create. Although a contract stating the worker is an employee or an independent contractor is not sufficient to determine the worker’s status.
Benefits. Businesses providing employee-type benefits, such as insurance, a pension plan, vacation pay or sick pay have employees. Businesses generally do not grant these benefits to independent contractors.
The permanency of the relationship is important. An expectation that the relationship will continue indefinitely, rather than for a specific project or period, is generally seen as evidence that the intent was to create an employer-employee relationship.
Services provided which are a key activity of the business. The extent to which services performed by the worker are seen as a key aspect of the regular business of the company.
When determining whether an individual is an employee or independent contractor, all the facts of the relationship must be considered.
Carefully consider how you're classifying your employees. Misclassification can lead to consequences, such as penalties for unpaid wages and employment taxes.
Contact us to find out how we can help you comply with your obligations and keep you out of trouble!
