Much attention has been paid to the tax increases that are part of the Democrat-backed Inflation Reduction Act that is making its way through Congress. And while these increases are troubling to businesses and taxpayers alike, there’s another rule coming from the Biden administration that will have an even bigger impact on costs for millions of small businesses: an impending change in worker classification rules. .
The new rules will result in the status of countless “independent contractors” being changed to employees. So why is it so important?
Small businesses rely on independent contractors to perform one-off, infrequent tasks that typically don’t require the attention of full-time employees. Often called “1099 workers” (thanks to the tax form that must be filed with the IRS to report payments over $600), these freelancers (or “temporary workers”) are independent business owners who often serve multiple clients.
They are truck drivers, software developers, project managers, construction workers, content producers, health professionals, counselors, and trainers. They belong to professional organizations that support the self-employed. Along with millions of others, they get projects and side jobs through platforms like five, craigslist, UpWork Y freelancer.com. Most of these entrepreneurs operate independently as small business owners and earn their entire livelihood this way. Others enjoy the extra income these freelancing opportunities provide.
But the Biden administration feels these independent contractors need more protections. And so the Department of Labor (DOL) is taking action.
“The department now plans to get involved in making rules to determine employee or independent contractor status under the Fair Labor Standards Act,” Jessica Looman, acting administrator of the Department of Labor’s Wage and Hour Division, recently wrote on the DOL blog. “We remain committed to ensuring that employees are properly recognized when they are, in fact, employees so that they receive the protections provided by the FLSA.”
The new DOL rules will eliminate the multiple requirements that have long been used to determine whether a freelancer is truly self-employed or should be classified as an employee and will replace these requirements with a more simplified “ABC Test.” These new rules focus on just three factors:
A: The worker is free from the control and direction of the lessee in connection with the performance of the work;
B: The worker performs work that is outside the normal course of business of the hiring entity and
C: The worker is habitually engaged in an independently established trade, occupation, or business.
For small businesses, the biggest challenge will be complying with the “B” rule. That’s because, in essence, that specific test basically says that a small business owner can’t use a 1099 worker to perform tasks that generate income for their business. The work must be “outside the usual course” of what your company does. So if he’s going to charge his clients for the services provided by the third-party developers and tax experts he uses, then he can’t treat these outsiders like independent contractors.
Instead, you must classify these workers as employees. And that’s a big problem for small businesses. Why? Because it’s a big tax increase. Small business owners will not only have to withhold payroll taxes from these workers, they will also have to pay the employer’s share of Social Security and Medicare taxes, as well as any related state and local taxes. As employees, they may also be qualified to participate in company benefit plans, which could incur additional health insurance and retirement costs.
Sure, these workers will also have protections under the Fair Labor Standards Act. They will also have the freedom to unionize (which many opponents say is the main driver behind the Biden administration’s actions). But do independent contractors and freelancers really want to be employees? Many contractors prefer to be their own boss and don’t want to be on a payroll. They like their independence. They serve multiple customers. They make their own decisions, from billing to the clients they work for and the hours they work.
“We told the Department of Labor that we want these attacks on our small businesses to stop,” He says Karon Warren, co-leader of Fight For Freelancers USA. “There are 59 million independent contractors in this country. We are a third of the US workforce and most of us are happy. Lawmakers and regulators must stop their outrageous attempts to misclassify us as employees.”
“The bill could end my ability to be my own boss, set my own hours, and otherwise live the dream of the American worker,” Judi Ketteler wrote in NBCNews.com. “According to the ABC test, companies should treat someone like me as an employee, with all the rights and benefits that implies, even if I’m just writing a story for them. The same goes for all kinds of creatives who support themselves through performances, such as actors, artists, and musicians. How many companies will continue to use our services in these circumstances? It’s just not feasible.”
Ketteler was referring to the PRO Law, a workers’ rights bill (modeled after California’s controversial AB5 legislation) that failed to pass the Senate in 2021. Despite this failure, the DOL continues to move out of the legislative process using parts of that legislation, particularly the ABC Test. The department held two public forums on the issue in June, and most experts expect the worker classification rules to be finalized by the end of the year.
It is inevitable that self-employment organizations and other business groups will challenge the ruling in court. there are already many legal challenges. And it’s important to note that the ruling comes from the DOL and does not affect how the IRS, a separate agency, defines independent contractors for tax reporting purposes. So confusion and chaos are also inevitable.
Meanwhile, countless small business owners will be caught in the middle. Amid inflation, supply chain issues, labor shortages, and a continuing economic slowdown, these changes couldn’t come at a worse time.
Gene Marks is founder of The Marks Group, a small business consulting firm. He frequently appears on CNBC, Fox Business and MSNBC.