The gig economy has caused an immense shift in employment practices, with growing numbers of Americans working part-time or as freelancers as companies continue to strip down to core staff, and step back from full-time employment. This can be a liberating step for smaller businesses, but every step toward small + smart structures means fewer individuals are covered by employer tax withholding and benefits coverage. State and Federal governments are pursuing greater regulation and auditing smaller businesses to try to find ways to grow tax revenues. Other states are pushing back against larger employers gaming the tax system, and catching smaller businesses in the storm of government oversight.
A case in point is a recent ruling in California with the potential to upend freelancer use in the ad industry.
California Ruling Cites “Core Function”
Ad agencies have long relied on freelancers and independent contractors to expand core staff when necessary, without acquiring excessive payroll overhead. Other benefits include the ability of smaller businesses to partner with people offering valuable expertise, knowledge and language skills to broaden business opportunities in global markets. But during and since the Great Recession, many kinds of businesses have embraced the contractor model to avoid carrying large staffs and heavy loads of payroll-and-benefits-related overhead—and to avert having to pay out unemployment or disability insurance should lay-offs occur. This has led to reduced tax revenues, and increased scrutiny from tax bureaus as well as tighter government regulation.
The Internal Revenue Service (IRS) applies specific rules to whether or not a business can deem a person a freelancer or independent contractor versus an employee. But in the gig economy, multiple court cases have added complexity and less wiggle-room for employers.
In April 2018, the California Supreme Court ruled that independent contractors may only be deemed freelance if they provide a service the agency does not offer as a “usual course” or core function. If, for instance, the agency does not have a video production unit, they are safe in designating a contracted video producer as a freelancer. If they have an in-house video production team, however, they may be forced to hire that producer as an employee.
Second Wind has already received some calls from California members about this regulatory change to how agencies use freelancers. It isn’t enough, apparently, for the IRS and state tax bureaus to demand businesses meet specific requirements—hours worked, how time is managed, how the worker is paid, and how tightly the company controls the freelancer’s work—to call a person a freelancer. Now, they may be barred from using freelancers at all, or incur substantial—and unsustainable—payroll costs. Some agencies speculate the ruling could lead to loss of freelancer relationships because those individuals want to remain independent; or even drive lay-offs of full-time employees in order to find a sustainable level of overhead. Damage to recruiting efforts is also a concern.
While some agencies have tested contracting freelancers though a third party firm like The Creative Group, where the TCG handles all taxes and benefits, the 10 percent markup on such a service undercuts project margins. We recommend that agencies review freelancer relationships at least annually to ensure they remain in compliance with State and Federal regulations regarding employee classifications.
Agencies across the nation should keep an eye on this issue in their home states. The California opinion, Dynamex Operations West, Inc. vs. Superior Court (S222732, April 30, 2018), is available online for interested readers.
New Support for Freelance Workers
Meanwhile, in New York, another center of changing freelancer rules, New York City partnered with the Freelancers Union to open the Brooklyn-based Freelancers Hub, a free training and resources facility offering co-working and networking space; classes on running a freelance business; information about worker benefits, health insurance and paid leave; and tax and legal advice. The city estimates 38 percent of its workforce is comprised of freelancers. In the first three months since opening, the Hub has signed up 4,000 members.
As states juggle the desire for additional tax revenues with the needs of small businesses reliant on freelance support, ad agencies should keep a careful eye on freelance/independent contractor relationships. If in doubt about how you’re handling these relationships, call Second Wind (610-374-9093). We’re happy to advise you on where you may need to alter practices, or provide suggestions on how other members are coping with freelancer/employer classification. Also, run contracts and agreements past a legal advisor to ensure you are in compliance with state requirements, as they vary from state to state.