As the number of independent contractors grows, it’s important to understand the key differences between these types of workers. As of 2019, the U.S. Department of Treasury and Internal Revenue Service (IRS) estimated the number of independent contractors in the U.S. grew 22 percent since 2001. That accounts for tens of millions of people.

Cold Weather Safety for Construction Workers

Cold Weather Safety for Construction Workers

How Defining Key Roles in Your Startup Could Impact Your Bottom Line

Legal Tips for Freelance Creatives

See All »

Worker classifications matter for several reasons, but at the heart of this controversy is taxes and labor laws. Independent contractors are not afforded the same rights as employees, like minimum wage or workers’ compensation insurance. It’s a situation that unscrupulous employers can take advantage of. But if an employer is caught misclassifying employees, they can become liable for additional taxes and damages.

“What was once an issue just on the minds of lawyers and regulators is now on the minds of everyday people across the country, thanks to the rise of the gig economy,” said attorney Richard R. Meneghello, a partner in Fisher Phillips’s Portland office. “Local lawmakers are now grappling with how to approach the issue of misclassification now that it has reached a high level of attention.” Meneghello has extensively litigated employment law matters and is well known for his writings on the gig economy.

Who Are Employees?

Employees are people who perform certain tasks for an employer. Because they are employees, the employer can dictate when, where, and how they perform these tasks. Employers can exert a great deal of control over employees’ work and final products or services. For example, an employer can dictate that an employee works in a particular office during set hours and, while there, performs specific tasks in a certain way.

Who Are Independent Contractors?

Independent contractors are essentially small businesses that provide products or services to many other businesses at a time or to one business for a short period of time. They have a greater degree of freedom in when and how they perform the required task or create the purchased product. The businesses they work with have far less control.

Key Differences Between Contractors and Employees

The IRS considers the independent contractor vs. employee classification important for tax withholding purposes. Businesses are required to withhold income tax, social security and Medicare (Federal Insurance Contributions Act taxes), and unemployment tax contributions for their employees. Employers and employees split FICA taxes, and the employee’s half is deducted from their paycheck.

Businesses aren’t required to withhold tax payments for independent contractors. Independent contractors are subject to self-employment tax, which encompasses taxes for social security and Medicare. While employees split their FICA taxes with their employers, independent contractors pay all of the FICA liability.

Employees receive a W2 at the end of the year. Independent contractors might receive a 1099 from businesses they work with. Whether a business has to issue a 1099 depends on several factors, which is why it is critical for contractors to track their income themselves.

Another key difference is found in regard to employment and labor laws. Employees are covered by numerous federal and state labor laws that dictate minimum wage, overtime, lunch and rest breaks, paid leave, and much more. Independent contractors are not covered by these laws, and by default, aren’t entitled to their protections. This distinction places independent contractors at a distinct disadvantage.

The Independent Contractor Classification Might Change Under State Law

Who counts as an employee vs. independent contractor for federal tax purposes depends on the IRS’s test, which is known as the Right to Control Test. The IRS uses a 20-factor test, and employers can use Form SS-8 to determine a workers’ proper classification.

However, states have their own tests, which impact state tax liabilities and state-based worker protections. As more people in the U.S. work as independent contractors, states are taking a closer look at the gig economy and misclassification.

“It appears that states are falling into one of three camps,” said Meneghello. “There are the states where leading lawmakers have announced they want to follow California’s footsteps and adopt an ABC test of their own.” The ABC test is considered the strictest test, and it’s created a lot of controversy in California and around the country. California made it much tougher for businesses to classify workers as independent contractors and avoid paying taxes or providing worker protections.

“New York is probably furthest down this road, and it appears that the lawmakers may have momentum for passing their own ABC test in 2020,” said Meneghello. “Illinois and Wisconsin may be next in line, and it wouldn’t be surprising to see Oregon and Washington follow this road.”

But many states took notice of the controversy surrounding California’s new law and are waiting to see how it all unfolds. “New Jersey is a perfect example,” Meneghello explained. “It seemed poised to pass a California-like law but instead backtracked and passed a very watered-down series of bills that will ramp up some misclassification risks but come nowhere close to the ABC test.”

The third type of state differs from California dramatically. Instead of restricting independent contractors, they’re supporting or even encouraging this classification. “They see the gig economy as a welcome innovation in their state spurring small business and flexible work arrangements and have altered their laws to further protect the right of gig economy companies to operate with a contractor workforce,” said Meneghello. “Tennessee is one such state, as are Texas and Florida.”

It's important to note that state legislators aren’t acting in a vacuum. Companies that rely on contractors are lobbying for certain legislation and aggressively fighting back in court when their worker classifications are challenged. “There are a series of other conservative states that have adopted laws (some of them supported by gig economy company, Handy) that protect the traditional contractor model associated with gig economy companies,” Meneghello said. Handy raised more than $100 million in venture capital and has drafted and lobbied for a bill that would make it easier for businesses to use contractors.

Are You Concerned About Misclassification?

Businesses might have to classify workers differently depending on a state versus federal test. A worker who is an independent contractor to the IRS might be an employee under the ABC test. Properly classifying workers helps businesses avoid additional tax and legal liability. Businesses who are concerned about misclassification should speak with an experienced employment law attorney.

Workers who believe a business has misclassified them should seek out legal advice regarding how to broach the subject with their employer or pursue a legal complaint.