Over the past couple of months, I’ve been engaged in a spirited debate with a friend regarding how employers are increasingly classifying workers as independent contractors, instead of W-2 wage employees.
So what’s fueling our dialogue? In short, the practice she works for is currently facing a decision as to whether the independent contractors they’ve long relied upon to perform operational and administrative duties should now be reclassified as W-2 staff. This issue has surfaced largely due to recent evidence of a crackdown on the part of the IRS and other government agencies against employers who have utilized independent contractors in defiance of prevailing regulations. While disagreeing with the intent of the law requiring employers to serve as a de facto middle man for ensuring that tax revenues are consistently collected and accounted for, she is correct in asserting that violating the law opens her employer up to some serious consequences, including some pretty hefty fines.
As a former human resources executive, now a business owner, who is well acquainted with the adverse bottom line ramifications of W-2 staffing, I believe that independent contractors are the way to go in terms of operational cost effectiveness. In reality, it can make all the difference in the world in terms of whether a company, such as the one at which my friend works, will ultimately survive financially. So for the vast majority of small and emerging businesses (which represent the fastest growing segment of the U.S. economy), the decision can come down to either breaking the law or keeping their doors open. It’s can be as simple as that.
Non-Compliant Businesses Face a Government Smackdown
Media buzz on this topic has been plentiful of late, as federal and state governments appear hell-bent in their efforts to stymie this independent contractor classification movement. On the other hand, the general consensus among business leaders is that this sort of crackdown will stifle innovation while making the cost of doing business onerously expensive. Many of these leaders say that this may force them to eliminate jobs in order for their businesses to remain buoyant and profitable.
Adding gasoline to this debate were the recent campaign speech comments made by presidential candidate Hillary Clinton, when she strongly endorsed redefining current independent contractors as employees. To me, this reflects the One Size Fits All Herd Mentality that statists constantly perpetuate. In a sense, what’s she’s saying to independent workers is ‘because we think businesses are out to screw you, let US define what a proper employment relationship looks like.’ Like a cow chewing over the same old cud, this view is another tired version of Industrial Age thinking that employees and the businesses for whom they choose to work are controlled by government as well as powerful side interests.
The Plight of Today’s W-2 Worker
And what about those who are currently W-2 wage employees? How do they really feel? Many with whom I cross paths tell me they appreciate having a steady paycheck and benefits. But in the same breath, I hear them howl like jackals at the onerous restrictions they are often placed under as a result of ‘working for The Man’. Many of them are quietly miserable yet hanging on for dear life because the work they are doing offers a sense of security. If you were to corner them for the truth, they would likely reveal their longing for a gig which allows them the freedom to do what they want to do, when they want to do it, and get well paid along the way. This mindset is particularly common among free-spirited millennials who see little value in the 9-5 Protestant Ethic, or retiring with the gold watch lifestyle that appealed to their parents’ generation.
Sadly, growing numbers of us independent contractors may be forced into choices that we may or may not want to make, if this W-2 movement gains traction. It’s here that political know-it-alls pretend to pose as advocates for today’s workers, while having little in the way of on-the-ground context in the larger economic milieu. For if the power elite in government gets their way, it will only serve to drive businesses to scale back and send work overseas in an attempt to remain financially viable. In the meantime, consumers could be harmed by reduced services and higher prices. And our nation’s independent contractors, well, this will simply be another sign that life, liberty and the pursuit of happiness is just a hollow mantra with no real substance.
Listen to your Lyft Driver, not Political Leaders
I happen to love the ride-sharing service Lyft. As a free-spirited city dweller, I revel in the thought of not owning a car nor having the cost and inconvenience of gas, maintenance, parking, auto registration and car payments. And, honestly, I get more real world information from the drivers in terms of how our economy really works than I do from all those sorry political leaders at the executive and legislative branches of government, replete with their single-digit approval ratings.
By way of example, I just talked to a 76 year-old driver a few weeks ago who discovered that his retirement isn’t quite what he thought it would be. Then there is the computer programmer who left a job he hated, and is now making just as much driving cars while having time on the side to start his IT business. And how about the single mom who is earning a little extra money on the side, fueling her endeavor to go back to graduate school.
This is just one example of how the the sharing economy, via flexible contract work arrangements, is boosting personal incomes as well as the overall economy in general. Thanks to mobile technology, the results have been nothing short of spectacular. Creative work arrangements, innovation, flexible jobs, and a fresh set of consumer options – all have ensued from this new normal of work relationships. But I do worry that one day this wonderful set of freedoms will no longer be available, due to status quo thinkers who want to see the independent worker-driven sharing economy destroyed. Whether it’s Lyft, Robert Half, AirBNB, or eLance, the impact in its full manifestation would be widespread.
So What’s REALLY Behind the Government’s Stance?
The rationale is pure and simple. Workers classified as W-2 offer a more efficient way for the federal and state governments to ensure timely collection and accountability for tax revenues. Period!
In some ways, I can’t argue with this because it is in the same vein as a for-profit business; the government wants its money pronto. In other ways, I get ticked when I hear about how this tax collection method has become a priority amid shortfalls caused by other forms of IRS inefficiencies.
The bottom line is that payroll taxes are a cash cow. The more workers who are classified as employees, the more milk and honey flows into government coffers, and the harder it is for workers to underreport or hide their income from the tax authorities.
Government officials lament the fact that independent contractor misclassification schemes deprive state and federal treasuries of billions of dollars in tax revenues. Moreover, they note that laws have existed for quite some time to clarify who is and is not an independent contractor. The key principle, according to the Labor Department’s 15-page guidance memo, is “whether the worker is economically dependent on the employer or truly in business for him or herself.”
Clear enough? Well, not so fast, as there is certainly an argument to be made that many businesses that misclassify their workers do so unintentionally, because the guidelines – when you put a shovel to them – are as clear as mud. Then when it is revealed that a business is in violation, the employer is reluctant to make the change, largely because for every contractor who is reclassified as an employee, there is an additional 20-30% in payroll and benefit costs assumed by the business.
This reminds me of a past client of mine, a weight-loss practice that elected to follow the rulebook by the letter and classify all staff as W-2 wage earners. Sick of hearing all of the griping and complaining among her team regarding how little they were being paid, the owner took the extraordinary step of revealing all of the financials of the business at one of their staff meetings. One of the employees, after a meticulous review of the report, immediately chimed in with what she detected was the reason for their paltry pay scale. “What’s this expense?” she blurted out. “If you made a cut to this, you could give us all a $2-3 raise.” Bemused, the owner retorted, “Well, those are the taxes I have to pay to the IRS on behalf of each of you team members, every pay period.”
As a postscript, it should be noted that this highly acclaimed weight-loss practice went out of business.
My Proposed End Game
So let’s conclude with two opposing end game scenarios, along with a third option.
First, if the government powers that be force an end to the contractor designation, employers will have to take on massive new burdens like withholding tax, providing health insurance and offering unemployment insurance, in addition to being subjected to myriad other onerous rules and regulations. And startups and early-stage businesses, needing additional talent while facing low profit margins, will be dead on arrival.
The second and more reasonable scenario in my estimation is to continue to allow some fluidity in the prevailing contractor laws. That way the workers become the real capitalists. They have the freedom to work when they are most productive, maintain their own equipment, and they have the flexibility to take time for family and other leisure pursuits. This arrangement also allows a flexible staffing model that’s amenable to fluctuating workloads. Businesses can hire people for short-term tasks and projects without having to endure the trauma, expense and legal issues associated with firings and layoffs.
Finally, there is a hybrid option where the federal government could require contractors to set up a business entity and bank account where they are paid under the business name. Then either on a bi-weekly or monthly basis, that contractor would initiate a W-2 payroll check from their business (through the use of an inexpensive payroll service) with the requisite taxes taken out. The benefits of this option would be the following triple-win proposition:
(1) IRS gets their money on a timely basis.
(2) IRS would no longer have to track and match up 1099s to ensure that they are not being stiffed by underreporting subcontractors, a loophole they are policing rather poorly.
(3) Contractors receive often overlooked tax deduction advantages as a result of having all of their money funneled through their business entity.
(4) The business owner has the freedom to manage their own destiny by becoming their own form of venture capitalist.
In the end the goal here is to provide thoughtful middle ground that offer a measure of worker freedom along with IRS compliance without being onerous to the employer.
Michael Scott is a Denver based writer specializing in feature stories targeting the intersection between free markets and social and economic freedom. He can be reached on Twitter @biz_michael