Another update from the Jungle…..
At this time of year, as we all think about income taxes and payroll withholding, the perennial issue arises. When is a worker an employee (IRS Form W-2) and when is a worker an independent contractor (IRS Form 1099)?
For decades the answer was straightforward: look at “control”. When a company controls what, when, where and how a worker performs assigned tasks, the worker is an employee. By contrast, independent contractors are given a task and a deadline, and they control how, where, and when they complete the task.
Then life got complicated. In 2015 the Dept. of Labor (DOL) proposed raising the salary level of the overtime rule to $913 per week. Employees with weekly wages below that amount would be entitled to overtime pay if they worked more than 40 hours in a work week. It meant that more employees would be eligible for overtime pay.
At the same time, the DOL adopted the “economic reality” test. If the economic reality was that a worker was financially dependent on the company, then the worker was a W-2 employee. The practical effect of the test was to eliminate the classification of “independent contractor”.
To understand why the DOL took these actions, it helps to understand the philosophical approach of regulatory authorities. Regulatory authorities, including the IRS and DOL, recognize that someone will always find a way to game the system. (Remember the tax shelters that allowed some people to claim they had no taxable income?) So the regulators try to deter gaming by creating tediously detailed regulations that everyone complains are strangling businesses and the economy. (Of course, we eventually learn how to game new rules and complain when they change again.)
In 2015, the DOL wanted to deter perceived abuse of the “exempt” status in the overtime rule, and it wanted to ensure that more individuals would be covered by an employer’s group health plan as contemplated by the Affordable Care Act. To meet these objectives, the DOL proposed raising the salary limit and adopted the “economic reality” test.
The economic reality test was withdrawn, and we’re back where we started with the “control” test. The proposed overtime rule was also withdrawn, and the DOL is considering raising the salary limit but by a lesser amount.
However, it’s still critical to properly classify workers because the consequences of getting it wrong can be financially catastrophic. DOL civil penalties start at over $1,000 per employee per violation. The IRS can assess civil penalties and require a company to restate years of tax filings. Misclassified workers can sue for lost wages and benefits. It’s a triple whammy that few companies could financially survive.
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Celia is the HR manager for her company and she handles the internal training when the staff needs to be updated about new employment laws or regulations. She’s been very busy lately preparing to explain the proposed regulations by the U.S. Department of Labor (DOL) on new overtime rules and the DOL’s new “economic reality” test for independent contractors.
After ten minutes, an employee asks how the new rules will affect his job. Celia tells him “we’ll get to that in a minute” and clicks through to the next slide. The third time she repeats that phrase, employees begin shifting in their chairs. Some employees surreptitiously check their devices for emails or the latest Candy Crush game.
Addison works for Rob, who has a consulting business. (We met Rob in last week’s post.) The work is sporadic and project-based but she likes it that way because she’s a free spirit. Addison worked for large corporations for many years and is happy to be on her own now.
The DOL recently said that it would no longer use the “control” test to determine if a worker is an independent contractor (1099 worker) or an employee (W-2 worker). Instead, the DOL plans to use an “economic reality” test. This new test has a number of factors but can be summed up by saying that if a worker is economically dependent on the employer, then the worker is a W-2 and not a 1099.
Rob has a small consulting business that does project-based work. That means Rob needs a flexible work force that can easily gear up when there are lots of clients, but can also gear down when projects are few.
economic reality test says that a worker who is economically dependent on an employer is an employee and not an independent contractor. Rob doesn’t know if his workers are economically dependent on him. He uses them part-time and always believed that they did work for other consulting businesses.
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