The #1 question I got from clients in 2022 about worker misclassification is the #1 question I’ve been getting over the last four months:
“Should my 1099 contractors really be my W-2 employees?”
I love HR compliance because it’s generally black & white … but the guidelines for properly classifying your workers are as grey as storm clouds.
The Independent Contractor rule under the DOL’s Fair Labor Standards Act outlines six factors to consider when properly classifying workers.
This “Economic Realties Test” – where a business leader determines whether a worker is either economically dependent on an employer for work or is in business for himself — is what you need to start assessing which bucket your workers fall into.
Unlike a real test, though, looking at these six factors doesn’t yield an immediate right or wrong answer – that’s what makes this question so murky and frustrating for my business owner clients!
But first …
Here’s a crucial insight that really hit home for me: recent data from the National Employment Law Project (NELP), indicates that a significant 10-30% of us might be misclassifying our workers as independent contractors.
I get the urge to cut costs, and it’s clear that classifying workers as contractors might seem like an attractive way to save money.
I also have several clients who’ve told me that their contractors refuse to become employees. Does that sound familiar?
Classifying your workers isn’t just a mutual decision you make with them – both the DOL and the Internal Revenue Service care very much if you pay someone as a “contractor” when they really fit the mold of “employee.”
So what is the distinction between W-2 employees and 1099 contractors?
W-2 employment is the classic employer-employee deal. These people dedicate their work hours under your watch, following a set schedule, company rules, and often, making a long-term commitment, or at least a commitment with no specific end date.
Now, enter the 1099 contractor scene- these individuals are often self-employed, serving up specific skills under a contract. Unlike your W2 team, they’ve got the freedom to call the shots on when and where they work.
As for the perks your employees get — besides whatever benefit you offer your employees just to recruit and retain the best, the government also mandates certain safeguards for employees, like retirement plans, paid sick leave, health insurance, worker’s compensation, and unemployment. Employees are covered by employment laws that create a safety net against unfair practices, discrimination, and workplace harassment.
Contractors don’t have these safeguards. Sure, they enjoy the flexibility and freedom, but the benefits game is a bit different. They don’t get the same level or perks and protections as your W2 team. Things like health insurance, retirement plans or paid time off aren’t in the cards for them – and the government is wary when workers aren’t properly protected.
That’s why I think it’s best for you to take a look at the Six-Factor Economic Realities Test from the DOL and figure out where your team members fit before the government does:
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- Opportunity for Profit or Loss
Contractors set and negotiate their fees and assume the potential profit or loss tied to their own work as service providers. In traditional employment, employees don’t generally make a profit or loss themselves – the employer organization does.
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- Investments in Equipment
Unlike employees where you cover their work expenses, contractors foot their own business bills. You furnish laptops, software, and other business tools for your employees, but contractors own their own equipment already and use them to provide their services to you.
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- The Degree of Permanence
Employees commit to a (hopefully) long-term relationship, with no determined end date, while contractors are often engaged for specific projects or a defined short-term period. Contractors can also work with multiple clients simultaneously, unlike employees who remain dedicated to a single employer.
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- The Degree of Control
You are the one determining employees’ work hours, location, and the specifics of how they get the job done. On the flip side, contractors are more independent; they decide when, where, and how they work in order to fulfill your service agreement.
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- Essential to the Employer’s Business
Essential roles are the backbone of your operations. If the work is fundamental to keeping your business run smoothly, it’s likely an employee’s role. On the other hand, contractors are specialists brought in for specific projects or tasks, contributing in a supplementary or project-based manner, but not central to your everyday operations.
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- Worker’s Skill and Initiative
With employees, you are directing how things are done. However, with contractors, you are giving them the autonomy to take the lead. They are expected to use their skills, take initiative, and determine the best methods to achieve project goals.
Not sure whether your current 1099s should really be W-2 employees?
If you’d like a clear, experienced perspective on your worker classifications — without guesswork or generic advice — you can book an HR Clarity Session with me. We’ll walk through your current setup and identify where you’re solid, where you may be exposed, and what to address first.
