by Shahar Erez, Co-founder & CEO of Stoke
2020 has brought in more freelancers on the job market than ever before. 95% of them want to keep freelancing in the future while 19.14% are expecting a huge increase in the demand for their services. The gig economy is here to stay and leave its mark — not just on companies and the overall job market, but also on the authorities.
As the freelance economy continues to grow rapidly, authorities have been paying more attention to the implications of classifying workers as freelancers. When a company decides to hire a freelancer, they don’t pay taxes, social or healthcare benefits for them, saving 30% to 35% on each worker. This gives companies one extra reason to classify their workers as freelancers.
Therefore, many governments have been passing new laws over the past 18 months. Their goal is to help companies understand when they can define a worker as a freelancer and when they must classify them as an employee. These guidelines are referred to as worker classification or employee classification, and unfortunately, they change from state-to-state and over time.
Due to its impactful consequences, the IRS, several states, and even the federal government have been investing consistent efforts into employee classification.
Here are the three main implications of employee classifications over different authorities.
1. Loss of tax revenues.
The IRS is one of the first authorities directly impacted when a company treats employees as freelancers. Organizations that classify employees as freelancers don’t pay taxes for these workers. This means the IRS is losing revenue even if the misclassification isn’t intentional and is just a result of sheer misinformation.
With employees, the employer is the one who has to withhold the income tax. Once a company decides to work with someone on a contract basis, it’s the freelancer who becomes responsible for these taxes.
The total sums are different for each situation. Self-employed professionals can deduce a large portion of the final tax they owe by reporting their business expenses. Tally it up and you’ll see just why the IRS has a fair reason to stay interested in ensuring companies are properly classifying freelancers. The IRS has also decided to increase the penalty for employers who misclassify workers and it can add up to $3 million per year for every contractor.
2. Protecting employees and providing their rightful benefits.
The government cares about proper worker classification since employees that companies treat as freelancers don’t receive the same law protection. They’re not getting any social, unemployment, or healthcare benefits they legitimately deserve. Each state has its own legislation passed with overtime payments and paid sick days to ensure employee protection.
The government’s ultimate goal? To have all workers receive the benefits they rightfully deserve and prevent their exploitation from companies. In fact, this is a public policy that aims to prepare people for their retirement and keep them covered by health insurance. For them, this brings more money and ensures that all workers are treated right.
This, however, doesn’t mean independent contractors are left without protection from the law. A contract is mandatory for companies collaborating with gig workers. This document outlines the exact conditions of the employer-contractor relationship.
3. Avoiding unfair advantages.
Employee misclassification also offers unfair advantages to the companies cheating the law. Working with a freelancer costs companies 30% to 35% less than an employee.
On top of this, working with employees requires extra resources and stipends that demand additional operational and administrative costs. This provides a huge competitive boost as companies who tend to work with contractors will have a higher budget left for other expenses. They can even contract more consultants, increase their marketing spending, and brag about their high profits.
With non-payroll workers heading towards a massive 90 million in 2028, companies have plenty of room to start hiring contractors for all the wrong reasons. Tax avoidance and evasion cause huge revenue gaps for both the IRS and the government. This leaves contractors with fewer benefits and could mean that people looking for a full-time job won’t be as desired by companies as they used to be.
The answer to the worker misclassification problem is setting up a legislature to describe exactly when a company can define a worker as a freelancer and what their benefits or regulations should be. Unfortunately, the current state-level laws are not clear enough in terms of their expectation from hiring managers. Companies are left unable to keep track of so many parameters and this can further extend the misclassification risk.
In the meantime, authorities have been raising penalties and running more audits, and this has increased awareness among legal teams. I can only hope that soon enough the government will be able to define one uniform and simple test that can help companies make better decisions.
Shahar Erez is a co-founder and the CEO of Stoke, an on-demand talent platform empowering companies to adopt a hybrid workforce model that scales as quickly and efficiently as needed. A tech-scene veteran in Israel and Silicon Valley, Erez has 15 years of executive experience in engineering, product and marketing under his belt. He has built a reputation as a strategic thinker who leads organizational change and drives growth by developing talent and promoting a learning culture.