You Better Mind Your W-2's and 1099's..or Else

By Caylyn Keller and Christina Saad

For business owners, misclassifying W-2 Employees as 1099 Independent Contractors can be detrimental. 

 If you are a business owner and have hired workers, whether your workers are legally considered employees or independent contractors makes a significant difference in your responsibilities to them. Under employment and labor laws, business owners are responsible for contributing to unemployment, healthcare, social security, and Medicare on behalf of their employees. Employers must also provide benefits to their employees, such as overtime and sick pay. Although small business owners may be exempt from providing certain benefits to employees, all business owners owe more protections to their employees than to their independent contractors. For instance, business owners do not withhold taxes for independent contractors and are not required to provide most benefits. 

 Proper classification of a worker depends on federal and state employment and labor laws. Improper classification by the employer can result in hefty financial penalties[1], legal fees, and potential jail time. Still, according to a 2015 report by the Economic Policy Institute, between 10-20% of employers misclassify at least one worker as an independent contractor.[2] While some of these misclassifications reflect deceptive attempts to curtail employment costs, many result from genuine misapplications of labor laws. 

The misapplication of employment-classification laws can largely be attributed to the ambiguous language found in the statutes and the lack of clarity business owners have in distinguishing between various classification standards. In addition to this, the recent trend across US states has been the enactment of classification laws which favor employees over employers. Some of these laws have created more stringent standards for recognizing a worker as an independent contractor than federal regulations do. Others have increased liability for employers by creating a private right of action for workers in misclassification cases. 

One state that recently enacted more stringent employment-classification laws is Virginia. Va. Code §§ 40.1-28.7:7. The law, enacted in 2020, established the presumption that any given worker is an employee.  While the presumption can be rebutted, the employer holds the burden of proving his or her worker is not an employee.  The Virginia Law also created a private right of action, enabling a worker to bring charges against his employer for allegedly misclassifying the worker as an independent contractor rather than an employee. 

 If you are a business owner and have classified, or intend to classify, a worker as an independent contractor, it is highly advisable that you contact an employment lawyer to assist you. After all, liabilities associated with misclassification are high, the legal standards are a bit muddled, and the laws are ever changing. Here at Taylor Law, PLLC, where we specialize in small business contract and employment law, we are more than happy to help. 

For general legal context, below I will provide the most common types of tests used by courts across the country to determine if specific classifications are improper.  

The “Common Law” Test

Under the July 2020 Virginia Law referred to above, the presumptive status of the worker as an employee can only be rebutted if the business owner can prove the worker meets the Internal Revenue Service (IRS) Test. Va. Code §§ 40.1-28.7:7. The IRS Test is fundamentally composed of the Common Law Test, or at least the IRS’s interpretation of it. 

In addition to the IRS and Virginia, the Common Law Test is used by numerous other states and the District of Columbia. 

Under the common law approach[3], in order to make the determination between an employee and an independent contractor, one must examine the relationship between the worker and business. The examination should assess the degree of control and degree of independence in the relationship and focus on three categories: behavioral control, financial control, and the type of relationship between the worker and the business. If an employer wields any of these controls over the worker, then the worker should be considered an employee.  

 The behavioral control assessment should focus on whether the business has a right to direct and control how a worker completes his tasks. Relevant facts include the extent of training and instructions supplied by the business to the worker. Typically, independent contractors tend to use their own methods to accomplish their tasks. The financial controlassessment looks at whether the business has a right to control the fiscal aspects of the worker’s performance. Some factors include: how the business pays the worker, the extent to which the worker can realize a profit or loss, and the extent to which the worker makes his or her services available to the relevant market. Facts which shed light on the type of relationship include: the type of relationship the parties’ intended to create, as indicated by the contract, the employee-type benefits provided by the business, the permanency of the relationship, and the extent to which services performed by the worker.  

 The “ABC” Test

At least half of the states use some form of the ABC test to distinguish between employees and independent contractors. The list includes Maryland, California, New Jersey, and even the Department of Labor. Some states use only part of the test, such as A&B or A&C.

The ABC Test[4] is the strictest legal test for defining independent contractor status and it establishes that a worker can be an independent contractor only if he or she: 

A) Is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of work and in fact;

B) Performs work that is outside the usual course of the hiring entity’s business; and

C) Is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

Other jurisdictions choose to impose their own unique tests. Whatever the case may be, Taylor Law, PLLC is here to support your small business needs. Ping us!

[1] An example of a financial penalty that a business owner may incur for misclassifying an employee is one imposed by IRS for 1.5% of wages, 40% of FICA taxes that were not withheld, and 100% of the matching FICA taxes the employer should have paid. https://www.burr.com/2019/07/17/irs-misclassifications-and-costly-penalties-independent-contractor-or-employee/.

[2] https://www.epi.org/publication/independent-contractor-misclassification/.

[3] https://www.wrapbook.com/worker-classification-tests-by-state/#:~:text=of%20their%20taxes.-,Common%20Law%20Test,the%20parties%20for%20each%20job.

[4] https://www.labor.ca.gov/employmentstatus/abctest/.