How to Manage Payroll in the Gig Economy
Key Takeaways
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The gig economy is rapidly expanding, with one-third of U.S. workers already participating and millions more expected to join, making it essential for payroll leaders to adapt.
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Worker misclassification poses serious risks, including financial penalties, compliance audits, and damage to your organization’s reputation.
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Future-proofing payroll strategies with flexible, AI-powered solutions enable organizations to stay compliant, meet evolving worker preferences, and remain competitive.
The payroll leader’s gig-economy challenge
In today’s fluctuating economy, employees are drawn to gig work, otherwise known as freelancing in temporary or contract-based job arrangements. Instead of being permanently employed in a traditional full-time role, gig workers rely on short-term contracts and are paid when the “gig” is completed.
One-third of the U.S. is engaged in some form of gig work, and that number is expected to rise. This is because gig work promotes ultimate job flexibility, especially during periods of economic uncertainty, when people can pick up more work if needed.
People also look for gig work to get paid earlier. According to a PayrollOrg survey, 34% of people want to access their wages sooner than their regular payday, which is an increase of 13% from 2022. With more people turning to gig work, you may find yourself managing different systems and processes for a mix of worker types, adding new layers of payroll complexity.
Pain points for payroll leaders
About 7% of U.S. workers are independent contractors, and most companies already rely on temporary talent, with two-thirds planning to expand their use. As gig work grows in popularity, the challenges you face as a payroll leader are inevitable. For example, managing independent contractor onboarding and documentation at scale. And once these employees are settled in, your team needs to navigate the complex and evolving compliance requirements across states and countries.
Another challenge you may face is handling the varying payment schedules involved with gig work, such as weekly, project-based, or instant pay. Because a lot of gig workers are hired seasonally, you also need to factor in shifting and scaling your workforce numbers for different times of the year.
Updating your payroll software will allow you to manage various employee types and schedules effectively. Legacy payroll systems can have operational delays and create compliance risks if they are not actively evolving to current employee trends.
While the idea of modernizing your payroll system may seem daunting, it’s crucial to adopt a solution that seamlessly integrates gig platform data with your existing HR and accounting systems.
Defining the multi-classification workforce
It’s important to ensure accurate worker classification to avoid costly penalties and audits. There are two common worker classifications: 1099 contractor and W-2 employee. This is how you can differentiate them from each other:
A 1099 contractor refers to someone who engages in gig work. They are also known as an independent contractor or freelancer who provides services to clients or businesses as needed. They do not receive employee benefits.
- A W-2 employee, on the other hand, is someone officially hired by an employer on a permanent full-time or part-time basis. Employers of W-2 employees have control over what work they do and how they do it. They receive regular wages and benefits from their employers, and they have specific tax and legal obligations.
What can become complex in your payroll processes is when you manage multiple worker types. Many organizations rely on permanent employees and project-based contractors, employing both 1099 and W-2 workers. It’s important to ensure everyone is classified correctly to avoid IRS compliance risks and costly fines.
To avoid the administrative burden of multiple payroll systems and compliance risks and penalties, payroll leaders should implement a united, flexible payroll system.
1099 vs. W-2 classification: The high-stakes classification decision
Consider the following three criteria when classifying employees:
- Behavioral control: How much control an employer has over the employee’s work and how it is performed.
- Financial control: How much the employer controls the financial and business aspects of the job; for example, how the worker is paid, whether expenses are reimbursed, and who pays for work supplies and equipment.
- Type of employment: Whether there are signed written contracts or employee-type benefits provided.
Gig workers are hired to perform a specific service, while employees don’t have as much control over how the work is done. These are the general rules to consider, but there are state-specific variations that may complicate multi-jurisdiction operations.
Misclassification red flags and consequences for payroll leaders
Employees can be classified as full-time, part-time, temporary, and contractors, among other employee types. Each classification has its own set of benefits, tax implications, and pay structures, so misclassification can come with serious repercussions.
Misclassification can be common, as it’s easy to overlook tedious employee situations, especially when you’re managing many employees. However, there are several serious risks associated with misclassification, including back taxes, penalties and audit costs, legal and regulatory actions, the long administrative process to correct actions, and damage to your organization’s reputation.
According to Taxcure, “Employers may face penalties of up to 3% of the employee's wages, up to 40% of FICA taxes that were not withheld, and up to 100% of the matching FICA taxes.” The employer also gets fined $50 for every unfiled W-2 tax form.
Under FLSA rules, misclassified employees are entitled to wages and overtime pay that they would have received if they were classified correctly, which can be costly for businesses.
A common misclassification pitfall is hiring someone as a long-term “contractor” who has worked for the same company for years with set hours, or integrating contractors into regular daily operations. Misclassifying permanent employees as “contractors” to cut costs, while still treating them like regular staff, can lead to serious consequences.
Additionally, a new U.S. Department of Labor rule that went into effect in March 2024 makes contractor classification more restrictive. The 2021 rule focused on only two core factors, the employee’s control over their work and the employee’s opportunity for profit or loss. The 2024 rule reinstated the “totality of circumstances” test, meaning that all six factors to assess a worker’s economic independence are weighed equally.
According to the Department of Labor, the government is replacing the 2021 rule with a new court-backed method to decide if a worker should be classified as an employee or an independent contractor.
These restrictions mean the misclassification of employees as independent contractors may deny them minimum wage, overtime pay, and other protections. This final rule reduces the risk that employees are misclassified as independent contractors while also providing a consistent classification approach for organizations.
How modern payroll solutions help
A modern payroll system can create a unified platform for all worker types, where the platform can manage both W-2 employees and 1099 contractors in one place. These systems often include built-in tools for syncing with HR and gig platforms and automatically stay up to date with multi-state compliance rules.
These tools provide you with operational efficiency at scale by automating administrative processes. This includes onboarding contractors with digital forms and processing bulk payments on flexible schedules, such as weekly, per project, or on demand. Mobile access capabilities also make it easy for both administrators and workers to manage tasks on the go.
Automated payroll platforms can also help you pay your employees how they prefer by supporting multiple methods such as direct deposit, instant pay, and digital wallets. They also automatically handle tax calculations and form generation while offering dashboards to monitor compliance and flag any issues early.
AI-powered payroll platforms make processes faster, smarter, and more transparent. They also handle administrative tasks and provide actionable insights to help make your workforce even more efficient.
Steps to get started with payroll automation
Getting started doesn’t have to be difficult. Here are the first steps you can take to make your payroll operations more efficient:
1. Build a strong foundation
Review your workforce and current payroll setup. Recognize the gaps in your payroll processes and potential compliance risks that could come up. Weigh the benefits of modernizing your payroll solutions to fit your organization’s changing needs.
2. Select the right technology
With the evolution of the workforce and more people seeking gig work for financial security, it’s important to choose tools built to manage contract work. Consider whether your selection will integrate smoothly with your existing systems.
Review solutions that incorporate AI insights for smarter classification, fraud detection, and real-time compliance monitoring. If you are unsure whether the solution is for you, start with a small test before scaling to your organization.
3. Prepare your team
Align your HR, finance, legal, and operations teams with your new payroll automation plan. Train your payroll staff and inform workers on how to use the new platform. You can do this by setting clear workflows and communication plans to ensure nothing gets overlooked in the integration process.
4. Keep improving your payroll processes
Once your payroll platform has been integrated, continue to track performance and compliance. It’s important to regularly update your processes and technology, as well as gather feedback to keep improving. Leverage AI insights to identify trends, flag anomalies, and optimize payment cycles over time.
Future-proofing your payroll strategy
Gig and contract work arrangements will continue to evolve and grow in popularity, with 26 million more Americans expected to join the side-hustle economy by 2027. In addition, AI and automation are expected to transform businesses by 2030, with 86% of employers anticipating AI transformation. It’s essential to prepare your payroll strategy and entire organization for these inevitable changes.
With rising workforce uncertainty, you’ll need to monitor changing regulations and prepare accordingly. Solutions that can scale to support tomorrow’s workforce are more valuable than ever.
In summary
The workforce is changing, and people are pursuing gig and contract work more than ever to remain financially stable. Staying ahead of workforce trends and actively preparing for the rising gig economy can be your organization’s competitive advantage.
Modern, intelligent payroll solutions can help your workforce keep up with multiple employee types and avoid compliance risks. To make a change in your payroll process, you must first assess your organization’s needs, align stakeholders, and evaluate vendors.
To learn more about how to create a business case for a modern payroll system, download UKG’s exclusive payroll eBook.
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