Worker classification series, part 1: what it is, and how it impacts you
May 14, 2019
In April 2018, a California judge ruled in favor of two delivery drivers suing their employer, Dynamex, for improperly classifying them as independent contractors. The judge employed the ABC test instead of the commonly used right to control test for worker classification in California. Since then, the state of independent work has been in flux in the Golden State.
Let’s stop there. If you have no idea what we’re talking about, you aren’t alone. This is a complex issue full of the legalese and jargon we usually strive to avoid on this blog, so we’re going to do our best to break it down for you.
In our three-part series, we’re going to break down:
- What worker classification is and why it matters
- What the different tests are, like right to control or ABC
- Some things we’re keeping our eye on in worker classification
What is worker classification?
So, what is worker classification? And what does this all mean?
At the highest level, worker classification is concerned with whether your employer says you are an employee or an independent contractor. This matters to the employer, tax authorities, labor authorities, and it should matter a lot to you, the independent worker, too.
The past and current landscape of work
Let’s hop in the way back machine. Around 1900, half of American workers were self-employed; by 1960, 85% of Americans were working for a company. Our economic systems are built and optimized around the center of gravity in 1960, where most of the workforce was traditionally employed.
Jump forward 50 years and the nature of work has blurred. Evidence today suggests that most people will experience an “episodic” career path- not only moving employers, but shifting between traditional employment, self-employment and periods of time where they do both.
Services provided by independent contractors through digital platforms further blur the lines. The platforms couldn’t exist without the workers who provide services. Uber isn’t Uber without drivers, right? The same could be said for platforms like Upwork or Postmates.
While worker classification issues aren’t new (rulings like the one in California last year have happened before), the stakes are different and to some, they are much higher. With the rise of self-employment and gig work via platforms, these rulings are shaping the future of independent work.
What’s more, California is not the only state where worker classification is a hot topic. Oregon, Texas, Louisiana, Tennessee- each state has an ongoing conversation about how to classify workers in their state.
Who has skin in the worker classification game
How employers classify their workforce has a direct impact on their bottom line. Workers classified as employees require the employer to withhold payroll taxes on the employee’s behalf, and to pay a portion of those taxes.
Payroll taxes include:
- FICA taxes, or Social Security and Medicare. The employer withholds the employees’ portion (7.65%) and pays their own portion (7.65%).
- Unemployment taxes. The employer pays 6% of your gross pay into the federal unemployment insurance program.
- Income taxes. Employers generally must withhold federal income tax from employees’ wages. They also submit income taxes on your behalf, each month.
Independent contractors don’t get a classic paycheck from an employer with payroll taxes withheld. They get a gross payment and are responsible for paying their own taxes. Also, its important to note that as an independent contractor, you must pay both the employer and employee parts of the FICA tax yourself, and you do not have anyone contributing to unemployment insurance on your behalf.
Simply stated, workers classified as employees are more expensive than workers classified as independent contractors. And, any worker who was not classified correctly could result in a lot of back taxes, back pay and fines.
While it is significantly less expensive to hire an independent contractor than it is to hire an employee, the employer shouldn’t be able to exercise as much control over the work. An independent contractor should be independent- how and where they do the work should be under their control.
Tax authority concerns
The IRS and your state tax authority care about your tax revenue. Workers classified as employees generally indicate a lower amount of administration (read, less paperwork), more frequent revenue (monthly submissions) and higher revenue. Workers classified as independent generally indicate the opposite for the tax authorities: a higher amount of administration (they don’t fit the norms!), less frequent revenue (quarterly submissions) and overall less revenue.
To be clear, it’s not that independent contractors are making less money, it’s that they can lower their tax liability via qualified deductions more so than a W-2 employee can.
Labor authority concerns
From a labor perspective, the Fair Labor Standards Act requires employees to be provided a minimum wage, and for non-exempt employees, overtime pay. Employees are also entitled to worker compensation. Independent contractors are not offered the same protections and minimums.
In addition, employees are protected by and from the employer under the Americans with Disabilities Act and Equal Opportunity Employment. Independent workers aren’t.
Your classification as a worker matters a lot. It impacts your access to benefits, how you pay taxes, your rights to workers comp and minimum wage, and ultimately how, when and where you work. Depending on how you see your future as an independent, potential changes could truly impact you.
If you made the choice to go solo and you want to stay solo, changes proposed like those in the state of California could make it more difficult for you to remain independent. On the flip side, if you want access to benefits and a steady paycheck, the update may be desirable.
Here are just a few of the issues under scrutiny:
- Length of assignment
- How much control the employer has over how, when and where the work is done
- Could the business exist without the work of the independent contractor?
Questions you might consider:
- Is your contract long-term or indefinite? Any role that is considered full-time and still “freelance”, and has an indefinite length is a red flag.
- Are you required to work on-site during a specific set of hours? In some states, this could be seen as an issue, especially under the “right to control” test.
- Do you have to be trained to follow a specific process? Again, in some states, this could be seen as a level of control over the work that would classify the worker as an employee.
That’s not to say that any single one of these issues would technically make you an employee or that you should be frustrated or annoyed if any of these are true. What’s at stake here is understanding the shift in the landscape that could ultimately change the way you work, for better or for worse.
What’s clear is that we will need to begin to settle some of these issues in order to more comprehensively address the needs of workers, no matter how they choose to work.
The next installment of our series on worker classification will address the most commonly used “tests” to determine status.