Independent Contractors and the Challenges of the New Gig Economy

As the gig economy grows and the number of independent contractors increases, employers must be aware of potential liabilities and notable differences in state and federal law, a payroll expert said May 18.

The number of independent contractors in the US is rising, said Pete Isberg, vice president of government relations for ADP, Inc. In 2021, the country had roughly 23.9 million independent contractors; by 2030, about half of all workers are expected to be independent contractors.

These statistics reveal the need for employers to keep informed of state and federal laws and regulations regarding independent contractors, he said at PayrollOrg’s 41st Payroll Congress.

“The laws are changing and varied and difficult to interpret,” Isberg said. “Do consult with legal counsel, do have consultants involved, and do what you have to to get legal support as needed.”

The federal government continues to issue regulations and guidance for employers on independent contractors and gig work, Isberg said. The Labor Department and Internal Revenue Service renewed their agreement to combat employee misclassification in December 2022, while the Federal Trade Commission and National Labor Relations Board created a memorandum of understanding to address labor developments in the gig economy.

Additionally, finalized rules regulating gig work are expected to be published in the Federal Register in the coming months, he added. These rules and agreements are all in addition to the IRS’s 20-factor test used to determine whether a worker is an employee or independent contractor.

Unfortunately, state and local laws and regulations for classifying workers as independent contractors vary and often differ from the federal government’s interpretation of gig work, Isberg said. One notable example is California’s “ABC test,” which is a three-factor test used to determine if a worker is an employee or independent contractor.

This can make it difficult for employers to determine an individual’s worker classification, since a worker might be considered an independent contractor under federal law but an employee under state law, Isberg said. Further complications can arise if an independent contractor crosses state borders and is considered an employee under the laws of the other state.

“I don’t know of any payroll systems that can produce a Form W-2 at the state level and a Form 1099 at the federal level” for the same worker, he said.

Companies can be subject to a multitude of penalties and fines for misclassifying workers as independent contractors, Isberg warned. In Virginia, for example, state contractors can be barred from receiving public contracts for misclassifying workers.

There are some ways the US and state governments can address worker classification, Isberg said. For example, in Montana, individuals may apply for an independent contractor exemption certificate, he noted.

“Maybe employers should start asking for that certificate if they have business operations in Montana,” Isberg said. “But, is it binding on the IRS? No.”

Another potential solution for the US is to adopt the “dependent contractor” worker classification that currently exists in other parts of the world, Isberg said.

“Where are we headed? In the UK, European Union, and Canada, they have a third class of worker,” he said. “They’ve got contractors, they’ve got employees, and they’ve got dependent contractors. And that concept sort of makes sense. We have a lot of contractors that only work for a single employer or hiring entity and they’ve been doing the same thing for years.”

Until states and the federal government find better methods for addressing the gig economy, employers should avoid treating independent contractors like employees, Isberg advised. This includes not offering employee benefits like paid leave and health insurance to independent contractors.

“Here’s a best practice: keep them separate,” he said. “Have a separate section for independent contractors and another for employees. And also, try to figure out what others in your industry do with their independent contractors.”