This is a repost of a piece I wrote 18 months ago. With so many more people forced by the COVID pandemic to survive as 1099 gig workers–and an election where the stakes couldn’t be higher for American workers–I thought it an opportune moment to readdress the issue of employees vs. “independent contractors” in America.
My blog spans an eclectic range of topics. Mostly, it’s a reflection of stuff that a) I know a little more about than the average jamoke, and/or b) has intrigued, tickled, or annoyed me during the past week. Which makes me a lot like Andy Rooney, I suppose. And for those of you who understood that last phrase, please reset your Geez-o-Meter before continuing.
Throughout my years of Not Being Able to Keep a Job, I’ve been an attorney and owned a start-up. I was fortunate to make a living at both and, as a result, I know some things. Among the Things I Know is that a lot of American companies abuse the heck out of hiring people as “independent contractors.” These are so-called “1099 workers” after the tax form on which companies report what they paid them. The quotation marks are intentional. In most cases, these contractors are anything but independent and look, act, and smell a lot like employees.
Contractors vs. Employees
Why, I hear you ask, should anyone care about these 1099 workers, gig or otherwise? Let me start by explaining the traditional common law difference between the two. In the common law, the distinction has long been between those workers whose conditions of employment are controlled by an employer and those workers hired to provide a specific thing or outcome.
Someone hired by a widgetmaker to work in his factory screwing Thingy A onto Whatsit B at $X/hour is an employee. Widgetmaker gives her the tools and tells her exactly what to do and when. Employee punches a time clock and gets paid by the hour.
By contrast, if you hire someone to build a house, that’s an independent contractor. You hand him plans and he gives you a bid for a finished house on a specified date. How he builds that house—how many carpenters, when to pour the foundation, whether he hires subcontractors—is not your concern. You just want a house that looks like the plans on the date agreed.
It’s a Common Law Thing
For a couple of centuries, this distinction worked well enough. Things started to change about 35 years ago. Companies began shifting the status of the people working for them from employee to independent contractor. Sometimes this occurred without notice to workers who showed up one day and were told they’re now independent contractors.
I hear you say, “Why does this even matter?” It matters a great deal, actually. Much of the legal protections afforded workers only apply to employees, not independent contractors. These include minimum wage, unionization rights, access to tax-advantaged benefits like health insurance or retirement plans, as well as unemployment benefits and worker’s compensation.
And the much-ballyhooed Gig Economy is driven by 1099 gig workers classified as independent contractors. They comprised almost 12% of the workforce before the pandemic accelerated the growth of this segment of the workforce. It’s too soon to know exactly how big this shift has been since March. We don’t have the numbers yet.
Deadbeat Employers Harm Us All
The American taxpayer also has an interest. Recall that Social Security and Medicare contributions are split 50-50 between employer and employee. This means each contributes 7.65% of the employee’s wages. If a worker is classified as an independent contractor, they’re responsible for all 15.3%. This presents a couple of problems.
First, in theory an independent contractor should get paid more than an equivalent employee. This is because the IC has to cough up double the payroll contributions as an employee. In reality, 1099 workers almost never get paid that much more than employees, so their net earnings are inevitably lower.
Second, collecting that 15.3% so-called “self-employment tax” from a gazillion 1099 gig worker-contractors is really, really hard. It’s certainly much harder than collecting payroll tax contributions for lots of employees from a single company. As a result, tax collection rates are significantly lower from independent contractors. So the Treasury and all of us dutiful taxpayers get stiffed. And this is as we’re getting dire predictions about the solvency of Social Security and Medicare.
Show Me the Bennies
Independent contractors aren’t eligible for employee benefit programs either. They don’t get employer-provided health insurance or access to tax-deferred 401k accounts. They also don’t get paid vacation or sick days–you don’t work a day, you don’t get paid for that day. This encourages people to come to work sick, work themselves to burn out, and avoid seeking medical care. We’ve discovered during the pandemic just how big the negative effects of this can be on both workers and the rest of us.
Even though independent contractors can fund their own Individual Retirement Account, the tax-deferred limit on IRAs is $6,000/year, while the limit on employer-sponsored 401k accounts is $19,500. If an employer offers generous matching, the 401k limit can go as high as a whopping $57,000/year. So the benefits deck is seriously stacked against ICs.
Again in theory, independent contractors should be getting paid more than equivalent employees to cover funding their own benefits. The reality is almost none of them get paid anywhere near this kind of premium over regular employees. In the tech sector, it’s just the opposite. Regular employees are paid much better than independent contractors working in the next cubicle and subject to identical employment conditions.
The IRS Has (Unenforced) Rules
The Internal Revenue Service, people with a great interest in collecting payroll taxes and a notoriously bad sense of humor, has developed a list of factors to determine whether a worker is really an employee and not an independent contractor. These fall into three broad categories:
— Behavioral Control: The employer says when and where to work, specifies what tools or processes to use, evaluates the details of how work is done, and/or trains workers how to do the job.
— Financial Control: The employer provides all the equipment the worker uses, pays all worker expenses, offers the worker no opportunity to participate directly in profit or loss like an owner, prohibits workers from doing similar work for anyone else, and/or pays the worker a regular salary.
— Relationship: The employer provides benefits such as health insurance or a pension plan or vacation days, an expectation that the relationship will continue indefinitely, and hires the worker to perform a key activity of the business.
We routinely see companies labelling workers independent contractors while setting mandatory work hours, requiring work in company workspaces, wearing company-logo clothing, mandating in detail the exact work to be accomplished on a daily or hourly basis, ordering workers to use the company timekeeping system, and placing workers under direct control of company supervision… or apps. (Think Uber and Lyft.) These companies refuse 1099 workers access to benefits enjoyed by senior management and regular employees. They simply ignore payroll tax contributions by telling independent contractor workers to pay their own “self-employment” taxes.
Misclassification and Anti-Competitiveness
Over the last five years or so, the issue of “misclassification” of 1099 gig workers has become very contentious. With the Lyft and Uber initial public offerings during the last few years, this issue is raging again. Two days before Uber’s IPO, thousands of their “independent contractor” drivers went on strike in a half-dozen major markets, protesting the company’s unilateral cuts to per-mile compensation and pressure on drivers to operate ever-increasing hours while sacrificing safety.
When I was an owner of a company that did programs for the State Department and Department of Defense, I saw another cost of deliberate misclassification of workers. A lot of large Government contractors do this as a matter of course and many smaller companies have followed suit.
My company went by IRS’s rules and classified people we hired honestly, almost always as employees. This made us suckers, because companies that ran the “independent contractor” scam enjoyed anywhere from a 15% to 30% reduction in labor costs. The more benefits we offered our employees, the bigger our price disadvantage became. If a competitor wasn’t paying their half of payroll taxes, that was an immediate 7.65% cost edge. No unemployment insurance or workman’s comp premiums? That’s about another 3-4%. No need to pay matching on a 401k (which my company offered), another 5% advantage. No employer’s share of health insurance? That’s another 8% or 9%. When you’re bidding services contracts that are basically all labor costs? Well, you see where this is going.
No One Is Minding the Store
The sorriest part of this was that the federal agencies for whom we were bidding work seldom did anything to prevent this. After all, the bottom line was cheaper contract costs to them. On the other hand, the US Treasury is getting screwed by their sister agencies.
Although many factors have contributed to increasing income inequality in America, the cynical abuse of “independent contractor” classification of 1099 gig workers who, by any objective measure, are employees is an important one. Maybe the record low unemployment rate pre-pandemic slowed the rush to make more employees “1099 workers.” If so, it only lasted until the pandemic-induced economic downturn. This ought to concern all of us.