Independent Contractor or Employee – Better Be Sure

Written by: ​Jimmy Norton, CPCU

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Employees or independent contractors?  This question has confounded employers, accountants, tax collectors and regulators for years.  Each option offers benefits and challenges.  Companies often classify their workers as independent contractors (1099s) to avoid the added expense of payroll taxes, employee benefits, unemployment, and additional insurance costs.  Unfortunately, the paper classification frequently does not describe the true relationship. 

This past year, several states and the Federal Government took steps to clarify the distinction between the two worker categories.  Regulators want to capture lost tax revenue and help workers regain entitlements lost due to misclassification by employers

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Virginia passed two laws in 2020:
  1. Effective July 1,2020, workers can sue their employers for past wages, benefits and other compensation.  Under this law, all workers are considered employees, and employers must prove that they are independent contractors to avoid liability for the prior expenses.
  2. The second law went into effect on Jan 1, 2021.  It prohibits employee misclassification and allows the Virginia Department of Taxation to impose civil penalties for violations. 
 
Who determines whom is what?

The Virginia laws use the IRS test to determine the correct classification. 


According to the IRS“The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”

Alternately, they use the common law definition of employee as anyone performing services for you “if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.”

The degree of control and independence can vary and create a huge gray area.  Businesses must weigh several factors which the IRS organizes into 3 categories:
  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
 
Washington DC uses the following:

The ordinary rules of common law relative to "master and servant" apply in defining  employers and employees. In determining who is an employee and who is an independent contractor, the Department of Employment Services considers the following:
  • Who has the right to supervise regarding the means by which the intermediate work should be done?
  • What is the method of compensation?
  • Is the individual providing service engaged in an independent trade, occupation, profession or business?

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Maryland’s Department of Labor uses similar standards to determine the difference between employee and independent contractor.  Their definition specifically cites the “right to discharge” as a distinguishing factor of the employer-employee relationship.  

The Department of Labor is also trying to “simplify” matters with its own updated Final Rule on Independent Contractor Status under the Fair Labor Standards Act , announced on January 6, 2021.  This rule is currently under review with a proposed effective date of May 7, 2021. 
 
The DOL rule relies on the core factors of 1) degree of employer’s control over the work and 2) the worker’s opportunity for profit or loss.  If those two factors don’t agree on the same classification, the Rule lays three additional factors: 
  • “The amount of skill required for the work.
  • The degree of permanence of the working relationship between the worker and the potential employer.
  • Whether the work is part of an integrated unit of production.”
 
Is there an insurance implication?  We will delve into that in our next post.  For now, take time to review the relationship with your workers.  Using the definitions above, how would you classify them?

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