It may soon be time to say goodbye for workers calling themselves “independent contractors” and the snow removal and ice management businesses that use them. Although much has been written about the advantages and disadvantages for both workers and businesses, controversy continues about who is an isn’t truly “independent.”
Those snow removal businesses utilizing independent contractors to minimize payroll tax costs and headaches have long battled the IRS and other government agencies over who is and who isn’t an independent contractor. Obviously, being labeled as an employee can have a profound impact on everything from overtime pay to fringe benefits and, of course, taxes.
THE FAST-SPREADING CALIFORNIA DEFINITION
A California law, Assembly Bill 5 (AB5) imposed some of the most significant restrictions on independent contractors in American history. Intended to force businesses to hire freelance workers as employees with health care and other benefits typically afforded to full-time employees, AB5 is now a reality.
California’s AB5 forced millions of independent workers to choose between becoming a full-time worker or not working at all. AB5 also restricted the ability of business owners to employ them, causing many to suffer.
Dozens of politically connected professions -- musicians, translators, writers, producers and photographers -- have successfully lobbied for exemptions and California voters recently approved Proposition 22, exempting Uber, Lyft and other ride-sharing and delivery providers from having to reclassify their drivers as employees.
While AB5 doesn’t exempt most contractors, it has guidelines that could, conceivably, provide a definition of independent contractors, definitions that are reportedly being considered by several other states. The three-part ABC test created by AB5 defines a worker as an employee unless the worker:
- Is free from the control and direction of the hiring entity in connection with the performance of the work,
- Performs work outside the usual course of the hiring entity’s business, and
- Customarily engages in an independently established trade, occupation or business of the same nature as the work performed.
The IRS announced that instead of reporting compensation for independent contractors on Form 1099-MISC, Miscellaneous Income, a new form, Form 1099-NEC, Nonemployee Compensation must be used. This will, presumably, allow them to better track independent contractors.
Fortunately, the IRS has another form, Form SS-8, that either workers or an employer can fill out to obtain an IRS determination on worker status. Although the IRS’s SS-8 program is helpful, there is some risk involved. According to the IRS, 72% of all Form SS-8 requests it received resulted in determinations that the workers in question were employees.
Surprisingly, about 90 percent of Form SS-8 requests are filed by workers -– which could explain the skewed numbers. Obviously, employers should be taking advantage of this process more frequently, notwithstanding the figures.
THE DEPARTMENT OF LABOR
Because the minimum wage and overtime protections of the Fair Labor Standards Act (FLSA) do not extend to independent contractors, the Department of Labor (DOL) has long been required to decide whether someone is an employee or an independent contractor. According to the DOL, even if someone is an independent contractor under another law, they may still be an employee under FLSA.
The DOL’s Wage and Hour Division (WHD) recently proposed new regulations for determining whether a worker is an employee or an independent contractor under FLSA. Under the proposal, status would be determined by the “economic reality” of the relationship and asking whether workers are economically dependent on a putative employer for work, as distinguished from being in business for themselves.
The primary focus would be on two “core” factors -– the nature and degree of workers control over the work, such as by setting their work schedule, selecting projects and being able to work for others and the opportunity for profit and loss based on their own initiative, investment, or both.
Other factors, including the required skill level for the work and the permanence of the working relationship, would be given less weight. And, the parties’ actual practice would be more relevant to the DOL’s labeling than that contractually or theoretically possible.
THE NATIONAL LABOR RELATIONS BOARD
Because independent contractors do not have a protected right under the National Labor Relations Act to form unions, the NLRB must sometimes decide whether workers are independent contractors or employees. The NLRB recently revised its 2014 classification test, emphasizing the importance of evaluating whether a worker has “entrepreneurial opportunity” for gain or loss in determining independent contractor status.
The basic principle from the 2014 classification test remains, however, namely that the more control the business exerts on a worker, the more likely the worker should be treated as an employee.
THE BOTTOM LINE
Independent contractors must pay both the employee and the employer portion of employment taxes. Plus, the pay-as-you-go nature of the federal tax system means independent contractors must usually “prepay” their tax liability by making quarterly estimated tax payments.
Unlike employees who can no longer deduct their employment expenses, independent contractors can deduct many work-related costs. Naturally, this requires good records. How are expenses treated for tax purposes?
- Out of pocket expenses are no longer deductible under current tax law;
- An employer may reimburse work-related expenses tax-free with an accountable plan.
- Ordinary and necessary business expenses are usually deductible and can include the following: materials, tools, supplies and uniforms; health insurance premiums; home office expenses; the portion of the cell phone bill attributable to business use; vehicle expenses, either actual or the current flat per-mile standard deduction.
The 2017 Tax Cuts and Jobs Act (TCJA) made independent contractor status more desirable for workers, especially high-income workers. Switching from employee to independent contractor status can mean a tax cut of between $12,500 and $24,000 annually for high income workers -- even considering the worker’s payment of the business’s former half of the Social Security and Medicare (FICA) taxes.
The snow or ice removal business that hires an independent contractor, rather than an employee, receives the financial benefit of not being required to pay its half of FICA taxes. The business also does not have to pay any employee benefits to anyone correctly labeled as an independent contractor.
Whether paid directly to an employee, an independent contractor or a “gig” platform, a snow removal business usually incurs a tax-deductible expense. Naturally, amounts paid to employees require additional payments of payroll taxes and the headaches associated with withholding the employee’s payroll taxes and payments of fringe benefits. Recipients of those funds must, of course, report those amounts as income.
The Government Accountability Office estimates that worker misclassification costs the federal government $2.7 billion per year, while both the IRS and the U.S. Department of Labor (DOL) believe that up to 30 percent of employers are misclassifying workers. Unfortunately, there is no uniform test to distinguish employees from independent contractors.
Government agencies such as the IRS, the DOL and the NLRB each have guidelines to define independent contractors. And, as illustrated by California’s AB5, Proposition 22, the same may be true in the state where the snow removal and ice management business is located. Professional assistance may be needed by all parties involved.