Cost. A word every company is familiar with. Employees come with costs beyond their compensation and benefits, like employer contributions toward healthcare, dental, vision, and 401k. And every time an employee is paid, the employer has to pay taxes based on employee wages. It varies how each type of payroll tax is calculated and administered by federal or state government(s).
State payroll taxes fund various programs which the employer and employee sometimes share. Since payroll taxes are paid on employee wages, some companies get around this by contracting with individuals as Independent Contractors (also known as 1099). It’s cheaper for the company, but is this practice legal?
What is an Independent Contractor?
The IRS has specific guidelines for classifying an individual as an Independent Contractor or an employee.
- How much control does the individual have? Is a work schedule dictated by the company? Does the individual have the autonomy to complete the task by a deadline?
- Does the Company dictate when and how the individual is paid? Are expenses reimbursed?
- Is there a contract that states what benefits the individual is or isn’t entitled to?
We have looked at federal government regulations/guidance as the baseline the states cannot go below. Take the minimum wage. While the federal government sets a minimum wage, you might be hard-pressed to find a state that doesn’t have a higher minimum wage rate for its citizens.
Some states even have additional guidelines, such as California’s ABC test. The ABC test is a three-step process to determine if a contractor is an employee or an independent contractor.
While the state asks the same questions as the IRS, they also ask if the contractor is performing work outside the usual business operations. States may appear only to want money from employers, but this is also a measure to ensure workers are treated properly under the Fair Labor Standards Act.
How Do You Know If a Contractor is Legal?
We often advise employers to ask themselves, “Is this position needed to make my company money?” If the answer is yes, it’s more than likely an independent contractor cannot fill this role. It might be time for an audit on your contractors to see if you are in violation.
What if you’re classifying your contractors wrong?
If you’re classifying your contractors incorrectly, change it now. Most state representatives understand that employment laws can be confusing, and sometimes you’re navigating this alone. If you’re audited and they see you made an immediate effort to right the ship, you have a better chance of smaller fines and penalties. You will likely be on the hook for back taxes and back pay to your contractor (possibly now employee). When in doubt, air on the side of less risk and liability, and convert your contractor to an employee. It might be less expensive in the long run.
Key Takeaway
Due to the shifting employment landscape, business owners must revisit and review their existing policies. At Think Global HR, we can help you evaluate your current policies—from hiring practices to compensation structures—to ensure they are up-to-date and compliant with state and federal laws. Book a call with us today to get started.
