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Eleanor Wilking, Independent Contractors in Law and in Fact: Evidence from U.S. Tax Returns, 117 Nw. U. L. Rev. 731 (2022).

Under tort and agency common law, the more control a firm exerts over its workers, the more likely that workers will be classified as employees rather than independent contractors. The need to determine control prompts a line-drawing exercise and offers opportunities for firms and/or workers to manipulate the result, rather than choosing the best abstract analysis on the facts. In Independent Contractors in Law and in Fact: Evidence from U.S. Tax Returns, Eleanor Wilking constructs a huge tax-return-based dataset and uses it to show that firms appear to game the employee/independent contractor distinction, that evidence of manipulation is stronger when lower-income workers are involved, and that the tendency to classify workers as independent contractors has likely increased over time.

A lot turns on whether a worker is an “employee.” Access to retirement plans, health insurance, certain government benefits and antidiscrimination protections follow from employee status. Tax, tort, contract, intellectual property and other legal results often differ based on whether a worker is an employee. Most, although not all, legal features require firms to offer more protections and benefits for employees, as opposed to independent contractors. Thus a firm’s incentive to manipulate generally tilts towards independent contractor classification, holding all else equal, particularly for lower-income workers.

Wilking created two datasets for this project. Both take advantage of the fact that different tax reporting forms for compensation are required according to worker status. An independent contractor receives a 1099-MISC or 1099-K, while an employee receives a W-2.

The first dataset is the “descriptive analysis sample,” shown in Table 1. This is an enormous data set with about 70 million observations, each a compensation information return linked to an individual tax return, drawn from a 2% random sample of all electronic W-2, 1099-MISC, and 1099-K filings available for the tax years 2001-2016. The second dataset is the “causal analysis sample,” shown in Table 4. This panel data set covers about 120,000 employees and includes ten years of data for each employee, starting when the employee is age sixty.

In her descriptive analysis, Wilking shows that independent contractor relationships, as reported on Forms 1099-MISC or 1099-K, have grown dramatically, from about 38 million to 57 million reports from 2001 to 2015. She proposes, based in part on a twenty-factor test developed by the IRS, that six quantitative metrics should correlate with independent contractor status. These are: smaller share of income, larger number of payers, longer distance between home and work, shorter job tenure, higher compensation volatility, and more business deductions taken by the worker. Wilking hypothesizes that independent contractor classification should correlate with each of these metrics, if the firms and/or their workers use an evenhanded application of the common-law test.

But Wilking finds that these metrics often do not differ significantly for independent contractors as opposed to employees, especially for workers whose income is below the sample’s median. For these low-income workers, share of income, number of payers, tenure, and compensation volatility generally converge whether a worker is classified as an independent contractor or as an employee (Figures 9-14). This suggests manipulation to achieve a better tax (or other) result, without any meaningful shift in the underlying facts of the work relationship.

The manipulation hypothesis draws some support from Wilking’s causal analysis. She exploits features of the Medicare rules that distinguish payment obligations for workers of age 65 or older based on whether the work is for a large firm, with twenty or more full-time employees; or a small firm, with fewer than twenty full-time employees. A large firm’s health insurance plan is the primary payer of worker medical expenses, and Medicare is secondary – but only for employees, since a 1099-MISC recipient typically is not covered by employer insurance. In contrast, for a small firm, Medicare is the primary payer of worker medical expenses, even for employees.  Wilking finds that, when workers in her sample turn 65, an employee at a large firm (proxied as a firm that issues at least 50 W-2s) is 0.08 percentage points more likely to transition from receiving a Form W-2 to receiving a Form 1099-MISC from the firm.

Wilking offers an imaginative use of a huge treasure trove of tax return data. Her results are powered not only by the enormous datasets she creates, but also by her creativity in fashioning quantitative proxies for the question of control posed by the common law of tort and agency. As compared to, say, the outcomes of reported cases, patterns of firm and worker planning are difficult to discover and describe. They are buried in countless private contracting and planning decisions that rarely receive any public attention. Wilking has figured out how to use tax return data to excavate patterns of private ordering that are usually hidden from view. What a contribution — both because of Wilking’s specific findings and because of her clever, large-dataset matching methodology.

To this original empirical contribution Wilking adds some tentative normative remarks. She invokes Professor David Weisbach’s classic criticism of line-drawing and reviews the incentive to manipulate or intentionally misclassify when discrete and different legal results lie next to each other on a continuum. She suggests that some such line-drawing exercises might eventually become obsolete. If they did, the question would arise of what should replace existing binary paradigms, like those that give firms and workers different benefits and responsibilities under many areas of law depending on how much control the firm has.

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Cite as: Susan Morse, Terms of Employment, JOTWELL (January 10, 2023) (reviewing Eleanor Wilking, Independent Contractors in Law and in Fact: Evidence from U.S. Tax Returns, 117 Nw. U. L. Rev. 731 (2022)), https://tax.jotwell.com/terms-of-employment/.