The ability to work hard and be productive while remaining flexible is a growing need of talent across the world. Flexible work is here to stay, but it has caused a critical compliance problem for many businesses and a slew of litigations and legislations, such as California’s AB5. On the surface, it may seem that AB5 makes having a flexible workforce more difficult. However, this article explains why there are actually huge benefits to legislation that clarifies the murky classification waters.

Some Background on AB5

California’s Assembly Bill 5, or AB5 for short, is a recent bill signed into law by Governor Gavin Newsom that went into effect on January 1st, 2020. Popularly known as the “gig worker” bill, this new law clearly defines the lines between independent contractor (IC) and a full-time employee (FTE). As it stands, many companies around the world contract with freelancers who may actually meet the legal definition of a full-time employee. 

Companies like Uber, Doordash, Lime, and many talent marketplaces are all being put through additional scrutiny because every employer in California that uses contract or freelance workers has to comply with the new law.

This particular law is only applicable in California, but every state has independent-contractor laws, and a lot of businesses are violating them without knowing it. This has been going on for a long time. Way back in 1999, Microsoft paid out about $100 million to a group of “independent contractors” who the court said were actually employees. This was over twenty years ago and not in California. With the Future of Work upon us, the government is clamping down on misclassification through legislation like AB5.

The Economics of Contingent Labor

Freelancers and contractors are mission-critical to many companies and it’s hard to imagine a world where companies are disincentivized to use them. Becoming employees does not remove flexibility, but it does protect the worker. Many independent contractors actually have the same commitment level, work, etc. of an FTE, but without any of the added benefits.

The biggest change in moving from contractor status to employee status is in how payroll taxes get paid. In the US, about 15% of gross pay goes to Social Security and Medicare. How that amount is paid differs for contractors vs. employees. A contractor pays the full 15% at the end of the year as “self-employment tax,” while an employee has 7.5% deducted from every paycheck and another 7.5% paid by the employer directly to the government.

Suppose you’re a business, and you engage a contractor who works 5 hours at $40/hour. You’ll write a $200 check, of which the contractor will owe $30 in payroll taxes, for a net of $170. If the same person worked as an employee, you’d pay out a total of $215 — $200 to the worker and $15 to the government — and there would be a $15 FICA deduction on the worker’s check, for a net of $185 to the worker.

Now if you do it exactly that way, then of course your costs have increased by 7.5%, but the worker’s net has increased by the same amount. It’s just a raise (or ‘zero-sum,’ to use a technical term). To keep the original economics, you would change the employee’s rate to $37/hour—that gets you back to $170 net for the worker and $200 spend for the employer.

The Direct Cost-Savings of Compliance

There are other economic differences between employment and contracting. Some are also zero-sum, like the cost of various types of insurance. Others are true net costs. At the end of the day, it costs 5% to 10% more to deliver the same take-home pay to an employee vs a contractor. That’s not nothing, but for most businesses it’s manageable.

In some cases, compliance can actually save companies money. For example, when companies misclassify an employee as an FTE when they should be an independent contractor, companies can instantly save 15% of costs per resources instantly. 

In addition, with more clearly defined laws and legal precedent, companies can use these resources in order to mitigate risks themselves. Along with this and recent cases within the Department of Labor (DoL), there exists a well-defined legal precedent which can be used by companies to determine best practices for their contingent workforce.

Want to save 15% on your contingent workforce? Chat with GreenLight’s team of experts today. 

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Alex Steeno

Alex Steeno

Senior industry analyst, adviser of multiple hypergrowth agencies, SaaS, and tech-enabled service platforms, Alex Steeno regularly contributes insights related to industry trends, growth marketing, and management consulting.

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