2023 UPDATE: New developments in independent contractor classification
On June 13, 2023, the National Labor Relations Board (NLRB) made a significant decision in The Atlanta Opera, Inc. case, which impacts the classification of workers as employees or independent contractors under the National Labor Relations Act (NLRA). The NLRB overturned the 2019 standard for classifying workers and reverted to a 2014 test, known as the FedEx Home Delivery standard.
It’s important to note that the NLRB’s decision is subject to review in court, which could lead to further changes. The Biden administration has also been finalizing a rule regarding independent contractor classification under the Fair Labor Standards Act (FLSA), aligning it with the court’s interpretation of the “economic reality” test. The exact release date for this final rule is uncertain, with the Department of Labor (DOL) indicating an anticipated release before October 2023.
What is the difference between employees and contractors?
First, it’s important to understand how employment classifications differ. For tax purposes, employees’ earnings are tracked on Form W-2, while contractors’ earnings are reported on Form 1099-NEC (in the past, it was 1099-MISC; 2020 marks the first tax year in which the IRS requires Form 1099-NEC). Employees are paid through payroll, which in turn generates the required withholdings and employer-side taxes. Independent contractors’ pay is not run through the payroll; in many cases, they submit invoices as vendors. For more information on payroll and contractor-related deductible expenses, download our comprehensive guide here.
There’s a lot more to understanding the differences between employees and contractors than the ways their wages are reported. Employees are covered by certain protections (including minimum wage and overtime requirements, as well as unemployment coverage and a variety of other legal benefits) that do not apply to contractors. Contractors receive different tax treatment—they don’t have income tax withheld from their earnings, they are subject to self-employment tax, and they also have the opportunity to take many tax deductions that don’t apply to employees.
What the new standard means for understanding employees vs. contractors
Under the new standard, the NLRB focuses on a worker’s “entrepreneurial opportunity” and assesses their functional independence in determining their employment status. The degree to which a worker can conduct business with other clients and the extent of their functional independence are now key factors in determining independent contractor status. Under this new test, a theoretical business opportunity is not enough; employers must confirm that their independent contractors are truly operating an independent business.
The NLRB’s independent business analysis requires consideration of whether the workers at issue:
- Can realistically work for other employers
- Retain a portion of ownership or other proprietary interest in the employer
- Possess control over key business decisions
In effect, the NLRB’s decision narrows the definition of independent contractors, making it more likely that workers will be classified as employees and be eligible for union and strike protections under the NLRA.
Control is the common theme
Control is the common theme underlying numerous tests from the NLRB, the Internal Revenue Service, and other state and federal laws. The more control the employer has over the worker, the more likely the worker should be classified as an employee. For example, if an employer provides a worker with all the tools needed to perform a job or project, dictates the individual’s hours of availability, sets the schedule and deadlines for the related tasks, and restricts the worker from providing similar services to others, then that person will most likely be considered an employee.
On the other hand, if a worker has his or her own tools, knowledge, and experience; sets milestone dates; determines the frequency of communication with the company; and does not have many restrictive covenants, that worker would probably pass as an independent contractor.
How can I get around paying people through payroll?
This is one of the most frequent questions we hear from business owners looking to save money and simplify their processes. In almost every case, the answer is, “you can’t and you shouldn’t try.” While there are valid ways to use the services of independent contractors in your business, owners must ensure they’re following the rules and compensating their workers appropriately. Misclassifying your workers can lead to crippling fines and penalties.
Stay informed, remain compliant when it comes to employees vs. contractors
The changing landscape of independent contractor classification creates challenges for businesses and individuals seeking clarity. In light of the new standard, many businesses may need to reassess the classification of their workers. Employers should review both the employment contracts and the practical aspects of the working relationship to ensure compliance with the updated rules. The control exercised by the employer, the method of payment, the worker’s tools, and the worker’s ability to provide services to others are all important considerations.
It is crucial for employers to comply with the evolving rules and avoid misclassifying workers, as the potential costs and legal consequences can be significant. Employers should consult with professionals and stay informed about updates from the NLRB and DOL to ensure compliance with the latest regulations. If you are uncertain of your workers’ classification and how any changes will impact your business financially, we’re here to help.