What California freelancers need to know?

Independent contractors are hired by an individual or business and provide their skills and services for certain tasks. Unlike traditional employees, the hiring company or individual can only control the results of an independent contractor's work. The rest is up to the contractor. Usually, the work is done on a contract basis with terms ending once the project or assignment is completed. Contractors can set their own terms, timelines and prices for a project.

If you're a freelancer or independent contractor earning $600 or more during a tax year from business or contract work, you will receive a 1099-NEC tax form. The business or individual that hired you must send the California 1099 form to the IRS and send a copy to you. As a 1099 worker in California, you are only responsible for the federal portion of your taxes. Before the IRS changed the requirements in 2020, the payments were reported on Form 1099-MISC. Now, all non-employee compensation is reported on Form 1099-NEC. Calculating taxes is no easy task, but an independent contractor tax calculator can help simplify things.

Anyone self-employed is required to pay self-employment taxes. Independent contractors in California are subject to a 15.3% tax, 12.4% for Social Security and 2.9% for Medicare. And since you are considered to be both the employer and employee by the IRS, this makes you responsible for paying the total tax amount, plus estimated taxes.

To help combat the confusion between an independent contractor and an employee, the IRS established the Common Law Test. If you’re a business owner in California, you’ll use this test to classify a worker as an independent contractor or an employee. Common-Law tests, or Right-to-Control Tests, determine whether a business can control what an employee does and how they perform. When an employer can only have control over the results of the work and not what the work is or how it’s done, it usually means the worker is an independent contractor. The Common Law Test looks at three factors:

• Financial control: Do any parts of the business control the financial aspects of the worker’s job?
• Behavioral control: Does the company have the right to control how workers do their work?
• Type of relationship: Are there employee benefits, or is there a written contract?

Financial control Five financial aspects impact a worker’s classification. Profit & loss opportunity Typically, a worker who makes more profit is an employee, while a worker with more loss is an independent contractor. Significant investment Independent contractors usually need to invest their money into their materials, tools and resources. Payment method Employees are added to the payroll based on a set salary amount. Independent contractors are paid on an hourly rate or project basis. Unreimbursed expenses Both employees and independent contractors can incur unreimbursed expenses. But some expenses may be reimbursed for employees. Market services Independent contractors can market their services and acquire more business. Employees need to follow company policy when it comes to side gigs. Behavioral control Four behavioral aspects impact a worker’s classification. Training A business might have a set training protocol in place for employees. Independent contractors might be free from following the training protocol and can follow their own procedures. Instruction type It typically means the worker is an employee if there are specific requirements for how, when and where the work should be performed (resources to use, sequence, etc.). Evaluation system Some businesses measure employee performance, including setting targets and goals. Instruction amount The more instructions there are, the more control the business has over the worker. Independent contractors have more control over their work. Type of relationship The type of relationship between a business and a company is key to distinguishing between an independent contractor and an employee. Benefits Benefits, including vacation days, paid holidays, maternity leave, health insurance and sick days are exclusively for employees. Contracts The contract should include how the worker and business will work together. Both can receive a contract, but the information in the contract can distinguish between the two. Relationship An independent contractor is typically hired for a set period of time. Employees can work at the company for an indefinite period of time.

How workers are classified impacts taxes. An employee on a payroll receives a W-2, and an independent contractor receives a 1099-NEC. The IRS has strict regulations in place and will impose penalties on businesses that misclassify a worker. Plus, it could trigger a tax audit.

In 2019, Assembly bill 5, or AB 5, was passed into law by California Governor Gavin Newsom. Effective January 1, 2020, this law uses an ABC to cover the Unemployment Insurance Code and Labor Code. The ABC test got its name from the three essential elements of the test —parts A, B, and C.