New Worker Classification Rule: W-2 or 1099?

The DOL issued a final rule, effective March 11, 2024, which makes it more difficult for an employer/organization to pay “workers” as 1099 contractors as opposed to W-2 employees. The new DOL rule broadens the definition of an “employee” with the intention that more workers should be classified as employees. As such, more workers will have the protections of the FLSA, which apply to employees but do not apply to “independent contractors.” This new rule replaces the previous 2021 rule as to worker classification. All employers should review the correct status of their independent contractors in light of this new March 11, 2024 DOL ruling. It is important to note that even though this is a worker classification ruling by the DOL, employers should anticipate that the IRS will classify more workers as employees in light of the broader employee classification of the DOL. The consequences of having a worker reclassified to employee status from independent contractor status involves potential back wages, penalties, back taxes for not withholding taxes from employees, possible retro-inclusion in fringe benefit plans offered only to employees, ACA violations which pertain only to employees, etc—GETTING WORKER CLASSIFICATION RIGHT IS EXTREMELY IMPORANT!!

HOW IS A WORKER CLASSIFIED AS AN EMPLOYEE OR INDEPENDENT CONTRACTOR UNDER THIS NEW DOL RULING?

Employers should review DOL Fact Sheet 13, published in March 2024, which provides significant details as to how the DOL new rule will classify workers (which replaces previous DOL worker classification rules effective March 11, 2024). The core concept of the new DOL worker classification final rule is dependent on the answers to the following: “Is the worker economically dependent on the employer? OR, INSTEAD, “Is the worker in business for themselves?” Most employers “know in their gut” whether a worker is their employee or is instead self-employed. It is not uncommon for employers to tell us who their “1099 employees” are for payroll—-which generally means they are W-2 employees, not self-employed workers/contractors. It is important to note here that the mere presence of a written “independent contractor agreement” does not change an employee to an independent contractor—-nor can a worker and an employer choose/decide to pay a worker “off the payroll” as a 1099 contractor. The substance of the relationship, not the “form,” determines who is an employee and who is a contractor. It is worth noting that a written independent contractor agreement can help an employer with provisions which are more suggestive of an independent contractor relationship, but the substance of the relationship will ultimately prevail.

The brand new DOL “employee vs independent contractor rule” includes 6 factors which should be reviewed for purposes of correct worker classification (the previous now rescinded rule from 2021 only included 2 primary factors). The DOL also indicates that all factors are “weighted similarly” such that the ultimate classification of a worker as an employee or “self-employed” is based on the “totality of the circumstances”—meaning all factors are considered rather equally in forming a correct conclusion as to a worker’s employee/contractor status.

THE 6 FACTORS ARE AS FOLLOWS:

• Can the worker make more money, or lose money, depending on their skill?—Can their decisions create profit for themselves or cost them money?—-Self-employed people (which is the essence of an independent contractor) can influence their profits or lose money
• What are the relative investments of money/capital by the worker and the employer?—-Purchasing one’s own tools or using their personal vehicle for work are generally small investments compared to the size of investments made by the organization
• Permanence of the work relationship—an employee generally has continuous work on more of a fixed schedule than an independent contractor—Independent contractors make their own decisions as to what work they perform and when
• Nature and degree of control—Does the employing organization have the right to hire, fire, schedule the worker or, instead, can the worker control their own schedule/hours and accept or reject work projects?
• Is the work done by the worker integral to the employer’s business?—-The core work of a business is generally performed by employees whereas non-core work can frequently be outsourced to independent contractors. Accounting is not the core business of employers other than an accounting firm, so outsourcing the accounting role to an outside accountant often results in a contractor relationship, in particular when the accountant controls their own schedule and work.
• Skills and initiative—Independent contractors often have a specialized skillset and take the initiative to grow the size of the work they are involved with (i.e, they build their own company).

REMEMBER—IT IS THE TOTALITY OF THE ABOVE CIRCUMSTANCES, NOT ANY SINGULAR ONE, WHICH RESULTS IN CLASSIFICATION OF A WORKER AS AN EMPLOYEE OR A SELF-EMPLOYED INDEPENDENT CONTRACTOR

WHAT CAN HAPPEN IF THE DOL OR IRS DETERMINE THAT AN EMPLOYER HAS INCORRECTLY PAID WORKERS AS 1099-CONTRACTORS, WHEN THEY SHOULD HAVE BEEN EMPLOYEES, ON THE PAYROLL?

Both the DOL and IRS have significant vested interests in worker classification. The DOL wants to provide minimum wage and overtime protections to employees, as well as ensuring that employees are included in the employer’s benefit plans, whereas the IRS requires that employers withhold, match and pay various income and payroll taxes to the IRS and various states/localities. Both the DOL and IRS can impose substantial penalties for misclassifying employees as independent contractors, along with back pay and back taxes. Employers who intentionally classify employees as 1099-contractors may also be prosecuted criminally by either the DOL or IRS.

ARE ANY INDUSTRIES KNOWN TO MISCLASSIFY EMPLOYEES AS 1099/CONTRACTORS MORE THAN OTHERS?

The DOL and IRS have indicated some industries in which incorrect worker classifications are more prevalent, and as such those they would be more prone to audit. Those industries include home care agencies, construction, food services and retail, along with the so called “gig economy” of workers (Uber, Door Dash, etc.)

WHAT SHOULD EVERY EMPLOYER DO?

Every employer should make a list of all their 1099-contractors and compare the details of those work relationships with the above 6 factors. If the result is uncertain or a “close call,” it is safer to classify a worker as an employee than a 1099 worker. Being full-time or part-time is generally not relevant for determination of employee or independent contractor status—we all know that many part-time employees work for employers.

The AccuPay HR team and our team of credentialed payroll specialists are here to help clients with questions regarding worker classification. Contact us at payroll@accupay.com