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IC Compliance and the Ins and Outs of How it Works in the US

HR & Compliance

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Updated on:
March 15, 2024
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Updated on :

March 15, 2024
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IC Compliance and the Ins and Outs of How it Works in the US


The rise of the gig economy has afforded both employees and employers tremendous benefits. But along with the benefits are common occupational hazards, e.g., Mislabelling of workers. And that’s why it is essential to know the IC Compliance, also known as the Independent Contractors’ Compliance, applicable in the region.

Sometimes the distinction between an employed staff and an independent contractor (freelancer) may be blurred when it comes to duty performance, leading to the organization incurring heavy fines when caught. Admittedly, some organizations deliberately mislabel their workers to save money. However, whether done intentionally or inadvertently, the organization is bound to face the law’s wrath when caught. Hence, the understanding of IC Compliance is essential.

What Is IC Compliance?

IC Compliance means Independent Contractors’ Compliance. It is a term used to broadly classify freelancers, contractors, and every kind of worker under the gig economy.

Independent contractors (IC) compliance is a set of guidelines, ordinances, policies, and regulations that protect the independent contractors’ interests and must be adhered to by every organization in a given state or region.

They exist because the laws governing traditional employees’ operations differ, and their benefits are not the same. Therefore, any organization willing to engage the services of these independent contractors – freelancers, entrepreneurs, contractors, consultants, etc., must abide by these regulations, or the authorities will penalize them.

For instance, it is the individual's ability to determine how they work. This varies by state, including California, which just passed AB5, which makes it more difficult to designate workers as Independent contractors.

One of the downsides of IC Compliance is its lack of universality across different regions. Different states have varying IC Compliance regulations, which makes it a complicated matter as a particular regulation protecting independent contractors in one state may not be relevant in another state. For this reason, the classification of workers has not been as easy as it should be.

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Employees vs. Independent Contractors

Tax filing and Taxation

In the United States, independent contractors and employees fill out different taxation forms. For employees, the tax form they fill is referred to as a W-2 form, while independent contractors fill out a form called the 1099 form.

A key difference in their taxation system lay in the organization’s payment system and reported to the government.

Taxes are automatically deducted from the workers’ paychecks and remitted to the organization’s government on each worker’s behalf. For independent contractors, their independence comes to play in how their taxes are being paid and reported. The independent contractor has the sole responsibility of calculating, paying, and writing their taxes to the government.

Work flexibility

One of the perks of being an independent contractor is the flexibility that comes with the role. Independent contractors are people that have built their business off a particular skill they offer. They are business entities on their own and call the shots in their operations. Meanwhile, employees in an organization have the responsibility of working based on the organization’s stipulation. The organization directs the location, when, and how to do their jobs. Typically, an employee works for just one organization while the independent contractor offers their services to multiple clients.

Security and other benefits

In the United States, the law protects the employees from being relieved of their duties without reasonable cause. This protection gives employees the job security that is not available as an independent contractor. Also, if employees get fired from their jobs, they can always fall back on the unemployment benefits that they are due.

The Fair Labor Standards Act ensures that organizations must pay employees above the minimum wage, and this law protects them against discrimination by employers.

Independent contractors are not entitled to such benefits as their work type ensures they source for these benefits independently.

IC Compliance in the USA

The United States is one of the countries that take IC Compliance very seriously. For instance, if an organization pays $600 or more to an independent contractor in a year, by law, the organization is required to report this to the Internal Revenue Service (IRS) using a form known as Form 1099.

Unlike employees, independent contractors do not have taxes withheld by the organization. The independent contractors are responsible for tax remission. Therefore, the avoidance of misclassification of workers in the United States is essential.

For employers, engaging an independent contractor is more straightforward than having an employee in the organization. This choice is because the employer and the independent contractor’s relationship is less expensive as employment taxes and administering benefits such as healthcare, retirement fees, holiday pay, etc., does not fall on the employer.

Therefore, the United States’ employment laws tend to be more strict for the classification of a worker as an independent contractor rather than an employee.

In the United States, Independent contractors’ compliance laws are not straightforward. Unfortunately, there is no generally defined compliance law as different states have proscribed laws regarding IC compliance and have to maintain the federal ordinances regarding workers’ classification.

Federal Laws & Regulations for Independent Contractors

The Internal Revenue Service (IRS) and the Department of Labor (DOL) are the two entities that prescribe laws and regulations regarding workers classification based on specific rules.

The Internal Revenue Service (IRS)

According to the IRS, the law views independent contractors as separate and privately-owned business entities engaged on a contractual basis by a hiring organization. The rules regarding workers’ classification as stipulated by the IRS govern the Type of Relationship, Behavioural, and Financial aspects in dealing with workers’ classification.

In classifying workers, the organization must answer questions that reflect and provide evidence regarding the worker’s degree of independence and control in the working relationship.

For the Behavioural aspect, the hiring organization must answer if they have the right to control what and how the worker carries out the task or if the company outrightly controls the worker regarding work affairs.

The Financial detail that must be satisfied by the hiring organization includes being able to ascertain if the hiring organization controls things like the worker’s system of payment and if expenses reimbursements are available.

The Type of Relationship queries if the organization and the worker have any written agreement or employee type benefits.

The Department of Labor (DOL)

Like the IRS, the law tasks the United States Department of Labor with prescribing the regulations that govern workers’ classification based on work rules and entitled benefits.

Indeed, these rules stand independently, just like the IRS rules. Recently, the DOL publicized a new test called the economic reality test. The test’s purpose was to determine the worker’s classification as either an employee or independent contractor. This new test uses two variables: The type and extent of the worker’s control over the work and the opportunities available to the worker based on investments.

The economic reality test also uses factors like the degree of skill required for the job, whether the task is part of the organization’s core operation and the level of permanence regarding the working relationship between the organization and the worker.

State Laws for Independent Contractors

One of the puzzles with the United States independent contractors laws is both the state and federal laws. Admittedly, this can either be a good or bad state depending on the organization’s situation.

According to federal law, there is the possibility of workers being classified as independent contractors and recognized differently under state law. In such conflicting events, the advisable measure is to adhere to the rule that applies a more strict standard for independent contractors and has more grounds for workers’ protection.

Different states in the United States choose the laws they deem fit for their workers. For Florida, Michigan, and Iowa, they follow the IRS standard law test.  

California, Virginia, and other states use a workers’ classification rule known as the ABC Test.

The ABC Test

According to the US Department of Labor, the ABC test is a test every labor employer must satisfy to classify a worker as an independent contractor adequately. Upheld in California and many states, this test has gained prominence with the corresponding rise of remote workers vis-a-vis the gig economy.

Under the ABC test, to classify a worker as an independent contractor, the organization must meet all three of the following conditions.

A: The worker is free from the control and direction of the hiring organization,

B: The worker’s duty for the hiring organization must be outside the usual course of the organization’s business, and

C: The worker is independently engaged in an established trade or business of the exact nature of the kind performed for the hiring organization.

As stated earlier, if there is a conflict between the federal and state laws, the organization must comply with the stricter law for independent contractors and be more protective of the workers’ rights.

About the author

Catalina Wang is a Human Resource Consultant. She manages recruitment, onboarding, and contract administration staffing for many organizations and remote teams. She’s passionate about efficient HR management and the impact of tech on hiring practices.

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