independent contractors

October 21, 2024October 21, 2024

How to Manage Compliance for Contractors

Summary

Managing contracted employees (1099s) fundamentally differs from managing typical W-2 staff.
Employers are legally responsible for correctly classifying workers according to the FLSA, IRS, and any applicable state-based rules. However, the line between employees and contractors can easily get blurred.
Workforce.com helps streamline contractor compliance management by ensuring workers are treated according to their classifications.

Suppose you are considering hiring independent contractors for a specific job. Or maybe you already employ a few. Have you done all of your research to handle them compliantly? If not, this guide is for you.

Strict labor standards govern how to properly classify and manage independent contractors, otherwise known as 1099 workers. Let’s examine how to stay on top of these rules and safeguard your business from legal risks.

Why hire an independent contractor?

Hiring independent contractors offers flexibility, especially when you need help for short-term projects. Unlike full-time employees, contractors usually come in with the expertise required to start working right away, meaning less time spent on training and onboarding.

Another advantage is cost-effectiveness. Contractors are not entitled to overtime pay, employee benefits like health insurance or retirement plans, or perks like paid vacations and promotions. You also avoid expenses like unemployment insurance and tax contributions that generally come with traditional employment.

While engaging independent contractors gives you flexibility, there are risks involved. Misclassification is the biggest one. Since contractors are not entitled to the many lucrative benefits of regular employment mentioned above, misclassifying an employee as a contractor can result in serious legal trouble, fines, back taxes, and even lawsuits. Because of this, it is vitally important to understand what qualifies someone as a contractor.

Key legal guidelines for managing independent contractors

Employee Classifications

Correctly classifying a worker as a contractor is the first step to staying compliant. At the federal level, the Fair Labor Standards Act (FLSA) uses a six-factor test that evaluates the “totality of circumstances” around the working relationship. With this assessment, businesses can determine the correct classification while considering crucial aspects such as control, independence, and the nature of work. These factors are:

Opportunity for profit or loss depending on managerial skill
Investments by the worker and the potential employer
Degree of permanence of the work relationship
Nature and degree of control
Extent to which the work performed is an integral part of the potential employer’s business
Skill and initiative

It’s important to note that the FLSA doesn’t assign a rule defining whether someone should be a contractor or an employee. Instead, it evaluates the facts of each situation to determine the working relationship and whether the worker is truly independent and doesn’t rely on the business like an employee would.

Aside from federal rules, businesses must also check if there are state rules that govern how they should differentiate contractors from employees. In California, for instance, a worker is classified by default as a standard W-2 employee unless all of the following conditions are met:

The worker is free from the control and direction of the hiring entity in connection with the performance of the work
The worker performs work that is outside the usual course of the hiring entity’s business
The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

In essence, a worker in California can only be classified as an independent contractor if they have autonomy over how and when they perform their tasks, as long as they complete their responsibilities. Also, the work must be fundamentally different from what the business does; For instance, a hospital commissioning people to construct a new building wing. Lastly, the worker must be independently engaged in an established trade and offer services to multiple clients.

Understanding the difference between independent contractors shapes how you manage payroll and benefits. Full-time employees are protected by wage and hour laws, ensuring they’re paid at least minimum wage and receive overtime pay. Full-time employees are also protected under meal break rules depending on the state. On the other hand, 1099 workers aren’t generally covered by these rules. Independent contractors are paid according to their contracts. In addition, they are not entitled to certain benefits, such as health insurance and workers’ compensation.

IRS Rules

Employers must also look at IRS guidelines because these will define how active their role is when handling taxes for their workers. It will also dictate how they report workers’ compensation, the types of forms to submit, and whether or not they would be legally liable to withhold taxes.

Employers withhold and deposit income taxes, social security taxes, and Medicare taxes from employee wages. On top of that, they also match contributions to SSS and Medicare taxes. But it’s a different situation for contractors. Employers generally don’t deduct income taxes from the contractor’s payment and don’t need to match contributions.

So, under IRS rules, what factors will help you gauge whether a worker should be classified as an employee or contractor?

Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how a worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
Type of relationship: Are there written contracts or employee type benefits (that is, pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Like California’s ABC Test, the IRS guidelines also consider the level of autonomy workers have over their jobs. Employers typically have less control over how contractors fulfill their tasks and don’t dictate the methods and tools workers use.

The IRS also considers how financially dependent workers are on their employers. Contractors typically cover their own costs, such as transportation and equipment, whereas employees rely on their employers for those provisions.

Employees typically have an ongoing relationship with an employer, while contractors typically work for a set period on specific tasks or projects and aren’t as involved in a company’s core operations.

Classifying employees correctly is also a prerequisite for filing the correct forms and determining whether you must file a W-2 or 1099. Employers typically file W-2s for full-time and part-time employees, reporting all wages, compensation, and tax withholdings for the year.

On the other hand, form 1099 shows how much an employer pays an independent contractor in a tax year. You must file a 1099 if a contractor earns $600 or more annually. These 1099 forms will not include tax withholdings since contractors calculate and submit them to the IRS independently.

OSHA Regulations

The Occupational Safety and Health Administration (OSHA) requires employers, including those using contractors, to adhere to safety regulations and keep workplaces free from hazards to prevent injury or death.

OSHA has general safety regulations that apply to most workplaces, but specific guidelines exist for construction, maritime, and agriculture industries. If you’re in any of those sectors, it would be wise to know these regulations.

Typically, OSHA regulations cover the following areas:

Safety training requirements include construction safety training, such as handling scaffolding, fall protection measures, and ladder safety.
Handling hazardous tasks, including hazard communication standards, proper labeling, data sheets, and training on handling hazardous substances.
Personal protective equipment (PPE) for specific working environments, including hard hats, gloves, goggles, or respirators, should meet OSHA standards.
Rules that must apply when multiple employers are present in a worksite, which is typical for big projects involving contractors and subcontractors. The company that hired them, the controlling employer, is responsible for following OSHA rules. This means that they must check for hazards, ensure safety standards are followed, especially with heavy equipment, and have a system to report and address safety concerns.

Aside from training, employers are also responsible for communicating such rules and ensuring that contractors have the safety training needed for the job.

How to build an effective contractor compliance management policy

Employing third-party contractors differs from managing employees, but your legal obligations remain just as important. It’s crucial to have a dedicated compliance strategy for employing contractors to reduce risks and avoid violations. Here are some practical tips:

Establish rules and guidelines for classifying contractors.

A significant part of contractor compliance is classifying them correctly, so you must have a process for doing so.

Before hiring, vet potential workers carefully. Assess the task or job and how you plan to oversee it. From there, you can determine whether a part-time worker or a contractor is the right fit. Getting the classification right from the start ensures compliance with tax filings, payroll, and other regulations.

Create airtight contracts.

Contracts and agreements between you and contractors must clearly outline the scope of work, duties and responsibilities, and payment terms. Draft them with the regulations in mind. To avoid legal missteps, ensure these agreements comply with FLSA, IRS, and OSHA regulations.

Avoid scope creep.

The law is very clear on factors that dictate whether a worker qualifies as an independent contractor. Remember that it all comes down to their financial and behavioral independence. Be careful not to overstep legal boundaries that could change their classification.

The key is consistency. Set clear rules for overseeing the job and adhere to the contract’s terms. Your treatment of contractors should remain uniform and standard throughout the project.

Provide necessary training.

Safety training is a must for hiring contractors. Ensure they complete all required health and safety training before the project begins.

It’s also in your best interest to train your managers on the legal principles governing contractors and employees. This can equip them during the vetting process and help them better manage projects in accordance with regulations.

Set regular progress check-ins.

See to it that the process stays on course. Establish regular check-ins where contractors submit performance reports detailing their deliverables, remaining tasks, and any challenges they face. This keeps you informed and allows for timely adjustments if needed.

At the same time, conduct routine assessments or audits from your end to track how the project is progressing. This helps ensure that contractors are set to meet deadlines and follow safety and health regulations. Regular check-ins keep the projects on track and minimize potential issues before they become bigger problems.

Stay abreast of relevant rules and regulations.

Labor laws can change at any time, so employers must stay up-to-date. Case in point: US Department of Labor’s final rule on worker classification. Previously, the law only looked at the economic dependence of workers on their employers. The more economically dependent a worker was on the employer, the more likely they were to be considered an employee. However, the changes take a broader approach and now consider the “totality of circumstances” when classifying workers.

Streamline the process with technology.

Contractor compliance can be complicated, requiring new administrative tasks and management processes for your managers and HR. However, technology can simplify some processes involved with working with contractors, such as onboarding, time tracking, payroll, and documentation.

Workforce.com simplifies contractor compliance

Managing employees is complicated enough, and adding contractors into the mix can come with its own set of challenges. But don’t let this discourage you from getting contractors for specialized projects, especially if they provide more flexibility.

There’s a way to manage contractors in a more streamlined way. Here’s how Workforce.com can help.

Onboarding

Workforce.com’s onboarding system lets 1099 workers easily and independently submit all necessary paperwork, bank details, and contracts to employers. This self-service portal relieves the administrative burden from the employer and ensures all information is in place for contractors to get paid correctly.

Time tracking

Depending on the contract, contractors submit timesheets before they get paid, but you can simplify the process with Workforce.com’s time and attendance system. Instead of dealing with paperwork, contractors can log in and out through the time clock, automatically generating timesheets based on their time punches.

You can set up a Workforce.com on-site or you can allow contractors to clock in and out through their own device via the Workforce.com app. This ensures accurate time tracking across multiple locations, making recordkeeping more manageable and ensuring contractors are paid on time, especially if specific hours were agreed upon.

Scheduling & task management

Workforce.com also has a scheduling system that contractors can use to plan their work accordingly. They can build and assign shifts, create to-do lists, and communicate with other workers to more easily map out where and when work gets done.

PayrollWorkforce.com’s payroll system can simplify how you pay contractors. Along with your W-2 staff, the system will also automatically process payment for your 1099 workers based on hours worked and the terms of their contract. At the end of the year, Workforce.com will also provide you with all necessary 1099 forms, which your contractors will use to file their taxes.

Recordkeeping

Workforce.com keeps all contractor records organized in one place, helping you access everything in case of audits or compliance reviews. It stores contracts, timesheets, IRS forms, and other important documents related to each project, helping you stay on top of everything and remain compliant.

Ready to improve how you manage contractor compliance? Book a demo and see how Workforce.com can help.

May 20, 2021October 22, 2021

More uncertainty for employers as Labor Department withdraws independent contractor rule

After months of anticipation, the U.S. Department of Labor withdrew its Independent Contractor Final Rule on May 5.

The Final Rule was published in the final two weeks of the Trump administration. Almost immediately following President Joe Biden’s inauguration, it became the subject of a delayed effective date (from March 8, 2021, to May 7, 2021) and notice of proposed rulemaking, in which the Labor Department proposed to withdraw the Final Rule before its delayed effective date.

In light of the Labor Department’s withdrawal of the Final Rule, employers will continue to be subject to the existing “economic realities” standard applied by the agency for determining whether a worker is an employee or an independent contractor. However, employers should remain vigilant as the Labor Department may soon revisit this issue.

The Final Rule had sought to clarify the relevant factors the Labor Department would consider to classify workers as independent contractors or employees. This designation is important because independent contractors, unlike employees, are not afforded minimum wage and overtime protections under the Fair Labor Standards Act.

Because the FLSA provides minimal guidance to employers regarding worker classification, the Labor Department and the courts have developed their own standards, including the so-called “economic reality” of the relationship between the employer and the worker.

Before the Final Rule, the Labor Department and most courts had long utilized a six-factor test for determining whether a worker should be classified as an independent contractor or an employee. The Supreme Court originally set out this test in United States v. Silk, indicating the following factors:

The employer’s versus the individual’s degree of control over the work.
The individual’s opportunity for profit or loss.
The individual’s investment in facilities and equipment.
The permanency of the relationship between the parties.
The skill or expertise required by the individual.
Whether the work is part of an integrated unit of production.

Since the Silk ruling, most federal courts and the Labor Department analyzed employee classification using a variation of the multifactor weighing test with all factors being given equal consideration. Indeed, in its primary regulatory guidance issued in July 2008, the Labor Department confirmed in Fact Sheet 13: Employment Relationship Under the Fair Labor Standards Act its reliance on the economic reality test and listed seven factors to be considered, which largely mirrored the six factors identified in Silk and added the “amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor” as an additional factor to be considered.

Breaking with the Labor Department’s prior practice of treating these seven factors as equally weighted, the Final Rule sought to pare the inquiry down to five factors and stated that two of those factors — the “nature and digress of the individual’s control over the work” and “the individual’s opportunity for profit or loss” — should be “afforded greater weight.”

As such, the Final Rule directed that only if the two core factors were inconclusive should the three remaining factors — namely, the skill or expertise required by the individual; the permanency of the relationship between the parties; and whether the work is part of an integrated unit of production — be considered.

Although many praised the Final Rule for simplifying what has become an inconsistent patchwork of approaches to the economic realities test in courts across the country, the Labor Department has since stated that the Final Rule was inconsistent with the FLSA’s text and purpose, and would have a confusing and disruptive effect on workers and businesses alike due to its departure from longstanding judicial precedent. Accordingly, the agency announced May 5 that the Final Rule was withdrawn effective immediately.

The Labor Department has not stated whether it intends to issue new guidance or regulations addressing the classification of independent contractors. Further complicating this issue for employers, both the initial delay of the Final Rule and its subsequent withdrawal are the subjects of a lawsuit pending in the U.S. District Court for the Eastern District of Texas brought by four employer-focused interest groups who seek the court’s intervention to declare the withdrawal unlawful and make the Final Rule effective.

The lawsuit is in its initial stages, and it remains to be seen how it will be resolved.

For the time being, all Labor Department regulations and guidance concerning independent contractor classification in place before the Final Rule’s publication continue to apply. However, given recent remarks by President Biden and U.S. Secretary of Labor Marty Walsh, the Labor Department may revisit the independent contractor standard.

If that occurs, it is expected that the Labor Department would take a more aggressive approach toward enforcement of worker classification laws and seek to further narrow the subset of workers who may be properly classified as independent contractors under the FLSA, particularly gig economy workers.

Notwithstanding the pending legal challenge to the withdrawal of the Final Rule, employers would be wise to evaluate their practices as to classification of employees and ensure that any independent contractors are properly classified under the Labor Department’s current 2008 guidance.

September 23, 2020September 23, 2020

DOL proposes rules to ease employer classification of workers as independent contractors

employment law, labor law, overtime records

The Department of Labor announced Sept. 22 a proposed rule amending its regulations on how to determine whether a worker is an employee covered by the Fair Labor Standards Act or an independent contractor not covered by the FLSA. This proposed rule is significant because the FLSA lacks clear guidance on these important definitions, which has left employers struggling, scrambling, and risk-taking to properly classify workers for purposes of paying overtime and other wage/hour obligations.

In this rulemaking, the DOL proposes to:

Adopt an “economic reality” test to determine a worker’s status as an FLSA employee or an independent contractor. The test considers whether a worker is in business for themselves (independent contractor) or is economically dependent on a putative employer for work (employee)
Identify and explain two “core factors”: the nature and degree of the worker’s control over the work; and the worker’s opportunity for profit or loss based on initiative and/or investment. These factors help determine the economic realities if a worker is economically dependent on someone else’s business or is in business for themselves; and
Identify three other factors that may serve as additional guideposts in the analysis: the amount of skill required for the work; the degree of permanence of the working relationship between the worker and the potential employer; and whether the work is part of an integrated unit of production.

You can download the entire proposed rule here, and it is open for public comment for 30 days.

As explained by Wage and Hour Division Administrator Cheryl Stanton, “The rule we proposed today continues our work to simplify the compliance landscape for businesses and to improve conditions for workers. The department believes that streamlining and clarifying the test to identify independent contractors will reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility.”

I could not agree more. These business-friendly rules would be a significant benefit to employers seeking guidance on a crucial issue that continues to be the focus on costly class action litigation nationwide.

September 15, 2016June 29, 2023

NLRB Is Now Basically Creating Unfair Labor Practices Out of Thin Air

Those that have been readers for awhile know of my dislike of the NLRB’s expansion of its doctrine of protected concerted activity (e.g., here and here).

The latest on the NLRB’s hit list: employee mis-classifications. The NLRB has concluded that an employer has committed an unfair labor practice and violated an employee’s section 7 rights by (mis)classifying its employees as independent contractors. Or so was the board’s conclusion in its recently published General Counsel Advice Memorandum [pdf].

The case involved drivers for a drayage company, whom the company classified as independent contractors. The company opposed a union’s efforts to organize the drivers on the ground that they were not employees covered by the National Labor Relations Act. Even after the NLRB determined that the purported contractors were employees subject to organizing, the employer still refused to re-classify them as employees.

In response, the NLRB Office of General Counsel concluded “that the Region should issue a Section 8(a)(1) complaint alleging that the Employer’s misclassification of its employees as independent contractors interfered with and restrained employees in the exercise of their Section 7 rights.” On the one hand, the GC’s decision makes some sense. If the NLRB determines that you have intentionally mis-classified employees with the specific intent of avoiding a union, then you have likely interfered with the rights of those employees to organize.

Yet, the GC’s decision goes well beyond the facts of the case, and concludes that even a “preemptive strike” in advance of any organizing campaign violates employees’ section 7 rights.

The Employer’s misclassification suppresses future Section 7 activity by imparting to its employees that they do not possess Section 7 rights in the first place. The Employer’s misclassification works as a preemptive strike, to chill its employees from exercising their rights under the Act during a period of critical importance to its employees—the Union’s organizing campaign.

Employers, thanks to the NLRB, your risk of employee mis-classifications (which is already sky high) just increased. Get ready to start fighting a two-front war against your independent contractors. Savvy plaintiffs’ lawyers simultaneously will file the FLSA lawsuit in federal court and, based on this Advice Memorandum, the unfair labor practice charge with the NLRB. Since an NLRB charge typically moves faster than a federal wage/hour lawsuit, expect the (unfavorable) Board decision first, and expect your contractors to argue the conclusive and binding effect of that decision in the FLSA lawsuit.

The NLRB is wading into uncharted and dangerous waters — creating an unfair labor practice out an alleged wage/hour violation. Moving forward, expect the employee friendly NLRB, and not federal judges, to decide whether you have classified your workers properly. This development is decidedly not to your benefit.

Jon Hyman is a partner at Meyers, Roman, Friedberg & Lewis in Cleveland. Comment below or email editors@workforce.com. Follow Hyman’s blog at Workforce.com/PracticalEmployer.