Independent Contractor (1099) or Employee (W-2)?
The news has spread about the California Supreme Court’s ruling in Dynamex vs Superior Court (Docket No. S222732). Dynamex
established a new 3-prong test that pushes owners to classify workers as employees (W-2) rather than independent contractors (1099-MISC). When asked how to classify dental associates and other staff, most legal and tax advisors have focused narrowly on this 3-prong test and are advising their owner-clients that all staff members need to be treated as W-2 employees. I believe that advice is both narrow and harmful, missing a great tax saving opportunity for both owners and high income workers. Here’s why:
- The 2017 Tax Cuts and Jobs Act makes independent contractor status far more desirable to workers than it ever was for owners. Switching from employee to independent contractor status now gives high income workers an additional tax cut of up to $18,000 annually – even though the worker ends up paying the owner’s half of the social security and Medicare (FICA) tax. These matched financial incentives permit owners and workers to be fully in agreement on independent contractor status!
- Dynamex states that the “underlying legislative intent and objective of the statutory scheme at issue” must be considered when applying that 3-prong test and other applicable law. What is that intent? There are two frequently cited “intent” categories used to support California legislation: to protect lower-wage workers with little negotiating power from owners that want to avoid employee-based costs (such as paying half of the workers’ FICA tax, and providing benefits to full time workers); and to prevent loss of tax receipts when owners fail to withhold taxes from workers who fail to pay taxes altogether. However, if the worker is a high-earner (like a dentist) who on the whole benefits from independent contractor status, the intent behind the law isn’t served.
- Based on the “intent” portion of the Dynamex ruling, owners and high income workers can and should cooperate in creating a comprehensive written contract, long before any government investigation occurs, to demonstrate that independent contractor status is both justified and mutually desired. In my opinion, that written contract must:
- describe how the worker’s particular fact situation satisfies the 3-prong test;
- use that description to show that legislative intent would not be served by treating the worker as an employee, and therefore independent contractor status is justified despite any weakness satisfying the 3-prong test;
- use that description to assure the owner that treating the worker as an independent contractor isn’t “willful misclassification” of an employee; and
- be instigated by the worker, either alone or jointly with the owner, to establish the worker’s good faith in arguing for independent contractor status.
This detailed description, along with other elements in the written contract, will help convince government investigators to pursue taxes and fines from far easier targets. Remember that when the California bear attacks all those independent contractor arrangements, you don’t have to kill the bear – you only have to make it harder for the bear to get you than to get all those other guys who don’t have a customized written agreement to protect them.
© 2018 by Robert W. Olson, Jr.