Getting Your Employee Classification Right

Getting your employee classification right is important. If you’ve been misclassified as a 1099 worker when you aren’t supposed to be, you could lose critical protections.
January 9, 2019

With the recent Uber controversy in California and the massive move towards gig economy jobs, how can you know if you’ve been classified correctly in a contract position? It might seem like a small detail, but if you’ve been misclassified as a contract worker when you aren’t supposed to be, you could lose critical protections.

It’s a complicated process, and there’s no magic line for what distinguishes a traditional employee from a 1099 contract employee, it’s worth your time to figure it out. Let’s go through how to sort it out and why you’ll want to know.

Why Does Employee Classification Matter?

We always hope that misclassification is a mistake, but in reality, employers sometimes do this on purpose. Misclassifying workers as 1099 employees releases the business from a host of financial responsibilities:

• unemployment insurance taxes

• Social Security payments

• employer Medicare contributions

• employer tax contributions

All to the tune of about 20-40% of labor costs. Misclassifying an employee earning a little over $43k a year could save an employer nearly $4,000 in labor costs. And that’s not all. Employers are also released from workplace protections:

• no minimum wage

• no need to abide by labor laws

• no EEOC (Equal Employment Opportunity Commission) culpability

• weaker unions (contract employees cannot join traditional labor unions)

• no employer covered health insurance or pension benefits

• no need to comply with immigration or work visas

Still not sure if you’ve got a reason to check? In a 2000 study commissioned by the DOL, up to 30% of audited firms had misclassified employees. A 2012 study was just as worrying. Misclassification could cost the country billions of dollars while creating unfair labor competition for firms able to lower labor costs over their competitors. And with a loophole, The Safe Harbor Provision, companies can claim reasonable misclassification and escape any penalties.

Again, some misclassifications are accidental, but this list is a compelling reason to check up on your employer’s actions. The stakes are too high for you and too good for your (potential) employer to assume your status is correct if you suspect something.

Making Sense of Employee Classification Laws

There’s no one set of standards that draws a line in the sand. Instead, the IRS (Internal Revenue Service) and the DOL (Department of Labor) look at the position holistically. Both determine the degree of independence and control between the employer and the employee.

IRS Test

The IRS looks at three categories to determine this delicate relationship.

Behavioral - Does the company control how you do your work beyond the scope outlined in the contractual agreement? For example, if you’re hired as a writer, does the company determine when and where you must complete your writing assignments?

This is more than just having a meeting once a week. If you are required to be at the company’s headquarters Monday through Thursday from 9:00 am to 2:00 pm to do your writing assignments, that sounds more like a part-time job. However, if your company gives you a writing assignment with a specific deadline and a meeting time TBD, it won’t matter how or when you do your assignment outside those parameters. Could be evidence of independent contract work.

Financial - Who controls the business aspects of your relationship? Does the business determine how and when you’re paid? Are you solely dependent on the business for your livelihood (within reason)? Who provides the tools you need to complete your job?

If you’ve been hired for 40 hours a week and have signed a highly restrictive contract, that doesn’t leave much time to take other clients for your livelihood. That could be indicative of a full-time employee position. If you’re free to take on additional clients and maintain a business presence, that might fall on the side of an independent contractor.

Type of relationship - Take a good long look at your employee contract. Do you have insurance? A pension plan in place? Employer-matched 401k? Is your work a vital aspect of the business functioning?

For example, if you walked out of your job today, would the business need to replace you to continue providing the services or products it offers? If the answer is no, you could be a contract employee. If the answer is yes, then your job is integral to the business itself. You’re probably a full employee.

These situations depend quite a bit on the position itself. The give and take of these three aspects can help determine if you’re truly an employee or not and the nature of the relationship, but what happens if you go through these and it’s still unclear to you? There is another recourse.

Department of Labor Economic Reality Test

The DOL also looks at the employee-employer relationship to determine the extent of control. The basic concept is deciding whether the employee is economically dependent on the employer.

The DOL looks at seven factors to determine this:

1. Are the services rendered an integral part of the business’s operations?

2. Is the relationship considered permanent?

3. How much does the contractor have invested in facilities and equipment?

4. How much does the “employer” control the worker’s actions?

5. What is the worker’s potential for profit/loss?

6. What is the amount of initiative, judgment, or foresight in open market conditions required for the “worker” to be successful?

7. What is the degree of independent business organization and operation?

The conditions vary, again, but in most cases, answering these questions can satisfy whether you are economically dependent on your employer. Again, if your typical job description requires a broad customer base, you may be a contract worker. If you’re hired full time, your sole economic stability is with your employer.

A Real Example

Here’s an example of how that might play out. When I was teaching, I was considered an employee. My school could not perform its duties without my position (teacher), and my position was the primary purpose of the business (ESL instruction). I showed up from 9:00 am to 4:00 pm and had a responsibility to teach during the hours I was assigned.

Now, I’m a freelance writer. When I write for Catch, I have a contract in place that stipulates agreed-upon deadlines, but whether I want to work on assignments at 2 am or 8 am is not up to Catch. Whether I write the entire thing in one sitting or space it out in five-minute increments forever is not up to Catch. And what happens if I quit being a writer? Catch might consider finding another content source, but the primary purpose of Catch isn’t affected.

Even if Catch decides to offer me the equivalent of 40 hours of writing work for the week, I still haven’t transitioned to “employee” because I have a choice to take it or not. Catch isn’t my primary income source and never agreed to be. Our contract stipulates that our business together is a project by project basis.

Unfortunately, not all positions are as cut and dry. With controversies surrounding Uber, Amazon, and other companies, it’s worth it to examine your position if you think you may have been wrongfully misclassified. Otherwise, you miss out on critical protections.

Still Unsure? Using IRS Form SS-8

If you feel like your employer has misclassified you and you don’t have the ability to change their minds, you can file an official inquiry with the IRS. The IRS has a significant stake in ensuring job positions are classified correctly. The IRS estimates that up to 85% of submissions are employees contesting their status. Keep in mind that results can take up to six months, but if you suspect you are misclassified and can’t make any headway directly with your employer, this could be one recourse.

Fighting Misclassification at the Source

Understanding your work terms before you start is a huge part of making sure you have everything you need for your economic stability. Working as a freelancer, contract, or gig worker is hard enough without the suspicion you may be entitled to more from your company. It’s always best to do your research and consult the proper authorities before making any determinations, but the sooner you start, the better.