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Written by: Jimmy Norton, CPCU
Employees or independent contractors? This question has confounded employers, accountants, tax collectors and regulators for years. Each option offers benefits and challenges. Companies often classify their workers as independent contractors (1099s) to avoid the added expense of payroll taxes, employee benefits, unemployment, and additional insurance costs. Unfortunately, the paper classification frequently does not describe the true relationship.
This past year, several states and the Federal Government took steps to clarify the distinction between the two worker categories. Regulators want to capture lost tax revenue and help workers regain entitlements lost due to misclassification by employers
Virginia passed two laws in 2020:
Who determines whom is what?
The Virginia laws use the IRS test to determine the correct classification.
According to the IRS, “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”
Alternately, they use the common law definition of employee as anyone performing services for you “if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.”
The degree of control and independence can vary and create a huge gray area. Businesses must weigh several factors which the IRS organizes into 3 categories:
Washington DC uses the following:
The ordinary rules of common law relative to "master and servant" apply in defining employers and employees. In determining who is an employee and who is an independent contractor, the Department of Employment Services considers the following:
Maryland’s Department of Labor uses similar standards to determine the difference between employee and independent contractor. Their definition specifically cites the “right to discharge” as a distinguishing factor of the employer-employee relationship.
The Department of Labor is also trying to “simplify” matters with its own updated Final Rule on Independent Contractor Status under the Fair Labor Standards Act , announced on January 6, 2021. This rule is currently under review with a proposed effective date of May 7, 2021.
The DOL rule relies on the core factors of 1) degree of employer’s control over the work and 2) the worker’s opportunity for profit or loss. If those two factors don’t agree on the same classification, the Rule lays three additional factors:
Is there an insurance implication? We will delve into that in our next post. For now, take time to review the relationship with your workers. Using the definitions above, how would you classify them?