1099 vs. W-2: Employers Should Take a Second Look at Their Independent Contractors

Employers need to revisit how they identify independent contractors in light of the U.S. Department of Labor’s proposed rule on employee classification, which will rescind its 2021 rule. Although RIN 1235-AA43 is not yet finalized, the period for public comment ended on December 13, 2022.

The proposed rule would require organizations to analyze whether a worker is economically dependent on the employer for work or is in business for themselves—which can be a complicated determination. The distinction is important and affects both parties. It determines whether the company issues a form W-2 (employee) or 1099 (independent contractor) to the worker at the end of the year. The decision also, of course, affects taxation and benefits.

Economic reality factors, as addressed in the proposed rule, have been described by The Society for Human Resource Management (SHRM) or business law firm Brooks Pierce as:

1. The opportunity for profit or loss depending on managerial skill.
2. The investments by the worker and the employer.
3. Whether the working relationship is long- or short-term.
4. The nature and degree of employer control over the work.
5. The extent to which the work performed is an integral part of the employer’s business.
6. The worker’s use of skill and initiative.

While employers should always discuss their specific situation with a qualified attorney, here’s an example: An independent contractor who presumably satisfies the proposed rule is an IT professional on retainer with an employer to provide IT-related services for several employees. Since the professional’s main business is IT, he or she should qualify as an independent contractor.

However, employers might be affected by the fifth economic reality noted above: the extent to which the work performed is an integral part of the employer’s business. Consider a customer service representative (CSR) working for an insurance agency remotely, in another state, for 20 hours a week reviewing policies before they are sent to the insured. Common sense suggests that the work is an integral part of the employer’s business.

If an independent contractor is indeed classified as an employee, they must be covered for FICA (Social Security); workers’ compensation; vacation; health insurance, if eligible; and other benefits and workforce protections. And this does not include regulatory issues at play. An employer might argue, “I’m paying a higher hourly rate to the independent contractor to compensate them for health insurance and retirement contributions.” The answer: That does not matter.

Another example is a salesperson who is getting a 1099 because they can “come and go, and work on straight commission.” Again, that No. 5 prong would apply because selling is an integral part of the business. Whether or not the classification was correct under the previous rules, many employers that have been issuing 1099s to their salespeople will need to switch to W-2s and all that the employee classification entails.

From: BenefitsPRO