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Should Your Client’s Workers be Classified as Employees or Independent Contractors to Optimize Taxes?

In the past few years, business reliance on the gig economy has skyrocketed. More than a third of American workers perform some sort of gig work, and that number is only expected to grow in the coming years. Using contracted workers can be a money saver for your clients, but they should proceed with caution. The legislative trends we are seeing at both the Federal and state levels promise that these working relationships will be under scrutiny in the coming months. As part of your annual tax planning services, help your clients understand the differences between employees and independent contractors to optimize taxes. If they come under examination by the Department of Labor, they should feel confident they’ve correctly classified their workforce.

More About the Gig Economy

The gig economy is the section of the workforce comprised of independent contractors and freelancers. These workers enter into short-term, temporary, and/or flexible contracts with one or more businesses rather than seek employment from only one company. Because these workers are self-employed, they can exercise more control over the work they perform for these businesses. In exchange, they are not provided health benefits or retirement perks, they are not reimbursed for most work-related expenses, and they are responsible for paying their own employment taxes.

Gig workers are common in all types of industries. Artists, writers, ride share drivers, delivery workers, coaches, trainers, teachers, consultants, and many more can be gig workers. It’s not the industry or the job that determines the classification but the relationship between the parties.

Department of Labor Employee Classification

Early this year, the U.S. Department of Labor (DOL) published a final rule that was going to help determine a worker’s employment status under the Fair Labor Standards Act (FLSA). This rule was initially scheduled to go into effect on March 8, 2021, but the implementation date was pushed back to May 7, 2021. On May 6, 2021, just before the rule was scheduled to go into effect, the DOL withdrew the final rule.

In this final rule, the DOL stressed that the “economic reality” of the relationship is what mattered. If the individual was, as a matter of economic reality, in business for themselves, they would have been considered an independent contractor. This economic reality tests first looked to two “core factors” and then to three “guidepost factors” to determine if an independent contractor was correctly classified. The two core factors were:

  1. The nature and degree of control the company has over the work being performed.
  2. The worker’s opportunity for profit or loss based on their initiative and/or investment.

If these two factors did not point to the same classification, the DOL would then look to the following three guideposts factors:

  1. The amount of skill required for the work.
  2. The degree of permanence of the working relationship between the worker and the potential employer.
  3. Whether the work is part of an integrated unit of production.

The DOL hoped that placing emphasis on these five factors would reduce worker misclassification. But because this rule has since been abandoned, employers must rely on legacy guidance from the DOL. There has never been a bright-line test for employee classification under the FLSA. Instead, the DOL considers a handful of economic factors when making the determination.

Current DOL Rule

Under the current guidelines, there are seven factors the DOL will consider.

  1. The extent to which the services rendered are an integral part of the company’s business.
  2. The degree of permanence of the working relationship between the worker and the potential employer.
  3. The amount of the worker’s investment in facilities and equipment.
  4. The nature and degree of control the company has over the work being performed.
  5. The worker’s opportunity for profit and loss.
  6. The amount of initiative, judgment, or foresight in open market competition with others required for the success of the worker.
  7. The worker’s degree of independent business organization and operation.

With all seven of these factors to consider, the employment status determination is highly subjective, leaving many business owners concerned the DOL will disagree with their conclusion.

Why Correctly Classifying Workers is Important

Employment classification is crucial for a few reasons.

Federal and State Protections

Employees and independent contractors are treated differently under the law; your client’s employees are protected under certain Federal and state laws while independent contractors may not be.

  • The FLSA is a Federal law that establishes protections – like a minimum wage, overtime pay, and child labor standards – for both full-time and part-time employed workers.
  • The Occupational Safety and Health Act ensures workplaces are safe for the business’s employees.
  • The Affordable Care Act (ACA) imposes penalties on employers who fail to provide healthcare coverage to their employees.
  • States often require employers to join their to protect employees who get injured or sick from a work-related cause.
  • The Family and Medical Leave Act (FMLA) requires employers who have at least 50 employees to provide up to 12 weeks of unpaid leave from job duties for employees.

If an employee is incorrectly classified as an independent contractor, they would be missing out these protections.

Benefits

The ACA imposes penalties on employers that have at least 50 full-time employees and fail to provide healthcare coverage. If your clients are nearing this employee threshold, they may be tempted to keep their employee numbers down by hiring independent contractors. But they should be careful; the DOL will not simply trust that your clients made the correct classification. They will look to the economic reality of the working relationship.

Your clients may also choose to offer retirement benefits, parking reimbursement, and other workplace perks to their employees. They would not extend these same benefits to Independent contractors.

Taxes

The tax requirements imposed on businesses that have employees is substantial. For each of their employees, your client must pay half of all payroll taxes and is responsible for collecting, remitting, and reporting those taxes to the government. They are also expected to withhold income taxes from their employees’ paychecks and remit those taxes on their behalf. Independent contractors file and pay their own taxes.

Tax Planning for Employees and Independent Contractors

If your clients know whether their workers are employees or independent contractors, your job becomes a lot simpler. With this information, you can help them make better business decisions. You can discuss employment and hiring decisions when you meet up for your annual tax planning session.

Any employment decision will be tough for your clients, but you can alleviate many of their other stressors by driving their tax plans. Our Corvee Tax Planning software allows you to hand select individual tax strategies that fit your clients’ needs. The software will even generate an easy-to-read report that shows them how much money they would save by following your suggested path forward. If you’d like to learn more about our planning software, request a demo today.

Tax Plan 2021: Corvee is Ready, Are You?

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