My blog spans a rather 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 actually understood that last phrase, please reset your Geez-o-meter before continuing.

US tax formNow throughout my many years of Not Being Able to Keep a Job, I’ve been both an attorney and an owner of a start-up consulting company. I was fortunate to make a decent living at both and as a result I know some things. One of the Things I Know is that a lot of American companies abuse the heck out of hiring people as “independent contractors” or so-called “1099 workers” after the tax form on which companies report what they paid them, not the familiar W-2 form employees receive. The quotation marks are intentional, because in most cases, these contractors are anything but independent and look, act, and smell a lot like employees.

Why, I hear you ask, should anyone care about this? Let me start by explaining the traditional common law difference between the two. In the common law—that being the kind of law Americans care about—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.

For example, a guy who’s hired by a widgetmaker to work in his widget factory screwing thingy A onto whatsit B at $X/hour for eight hours a day is an employee. Widgetmaker gives her the tools to do the work, instructing 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 the finished house to be completed 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.

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 without any notice to said workers who showed up one day and were told they were now independent contractors and no longer employees.

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-talked-about Gig Economy is driven by 1099 worker independent contractors, who comprise almost 12% of the workforce and growing rapidly.

The American taxpayer also has an interest. Remember Social Security and Medicare contributions are split 50-50 between employer and employee. Currently, 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 a similarly situated employee, since the IC has to cough up double the social insurance contributions of an employee. In reality, that’s almost never the case so the net earnings of the IC are inevitably lower.

Second, collecting that 15.3% so-called “self-employment tax” from a gazillion independent contractors is really hard. Certainly much harder than collecting payroll tax contributions for lots of employees from a single company. As a result, tax collections are significantly lower from independent contractors. So the Treasury and all of us dutiful taxpayers get stiffed, just as we’re getting dire predictions about the solvency of Social Security and Medicare.

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 that day. This encourages people to come to work sick, work themselves to burn out, and avoid seeking medical care. 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 $19,000. If an employer offers generous matching, the 401k limit goes to a whopping $56,000/year. So the benefits deck is seriously stacked against ICs.

Again in theory, ICs 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, the reality is just the opposite—regular employees are paid much better than independent contractors who may be working in the same building or even in the next cubicle, subject to identical employment conditions.

The Internal Revenue Service, a bunch of people with a great interest in collecting payroll taxes and a notoriously bad sense of humor, has developed a list of factors to consider in deciding that a worker is actually 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.

independent contractor exampleWe routinely see companies labelling workers independent contractors while setting mandatory work hours, requiring work in company workspaces wearing company-logo clothing, mandating in minute detail 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 IC workers access to benefits enjoyed by the senior management and regular employees and simply ignore payroll tax contributions by telling IC workers to pay their own “self-employment” taxes.

Over the last five years or so, the issue of “misclassification” of workers has become very contentious. With the Lyft and Uber initial public offerings during the last few weeks, 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 start-up company that implemented programs for the State Department, US Agency for International Development, and Department of Defense, I experienced another unseen 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 out to be suckers, because companies that ran the independent contractor scam immediately enjoyed anywhere from a 15% to 30% reduction on total 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 any matching on a 401k (which was what my company offered as a bennie), another maybe 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, right?

The sorriest part of this was that the federal agencies for whom we were bidding work seldom did anything to prevent this, given that the bottom line was cheaper contract costs to them. On the other hand, the IRS is also a federal agency and they–and the US Treasury–were getting screwed by their sister agencies, too. 

Although many factors have contributed to the increasing income inequality gap in America, the cynical abuse of “independent contractor” classification of workers who by any objective measure are employees is an important one. Maybe the record low unemployment rate will slow the rush to make more employees “1099 workers,” but that will only last until the next economic downturn. That ought to concern all of us.

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