About 20%–30% of today's workforce in Europe and the US engages in some form of independent work, according to McKinsey, and those numbers will continue to grow.
Such growth in the gig economy, along with increased attention from the US Department of Labor and state governments looking to avoid losing payroll taxes, means it is more important than ever for businesses to understand the difference between employees and independent contractors (ICs).
Misclassifying workers as ICs can trigger an IRS or state tax audit, an investigation by the US Department of Labor, as well as lawsuits by improperly classified employees. These can all result in hefty fines, penalties, business interruptions and bad press.
Unfortunately, many businesses get into trouble by assuming that calling workers ICs makes them ICs. Not fully understanding the complex maze of laws governing ICs' classification or relying on outdated practices can lead to expensive missteps. Establishing a clear and comprehensive independent contractor compliance program can help avoid these pitfalls.
Here are three factors you need to keep in mind to ensure your IC compliance program won't run into trouble.
Understand the rules
No bright-line test exists to determine whether an individual or entity qualifies as an independent contractor. Different agencies use their own tests and standards, with the result that someone might be considered an IC for some purposes and an employee for other purposes. For example, in the US, the IRS uses a 20-factor test for federal income tax purposes, basing much of its criteria on who has control over certain decisions, such as who determines where and when workers do their jobs.
On the other hand, the US Department of Labor uses the economic realities test, which emphasizes the
degree to which the worker depends on the income from a company. Different sets
of factors are used when considering
It is important to take a realistic look at whether your company has the internal expertise and resources to effectively vet ICs. If not, consider engaging an external compliance specialist to help (e.g., a law firm or reputable independent contractor compliance company).
Establish a consistent vetting and engagement process
With increased regulatory attention and an active plaintiffs' bar looking for lucrative class action cases, minimizing the risk of misclassification is imperative. A consistent and straightforward process will reduce the risk of hiring managers and engagement managers circumventing the process.
First, review your current IC compliance process. Do you have written processes and policies? If so, are they being followed consistently companywide? Do your managers understand the rules and the importance of proper classification? Is following the process prohibitively complicated?
Next, establish clear
policies and procedures for vetting ICs and maintaining compliance files. Consider
who will handle the process: Will it be someone internal, or will you outsource
it to a third-party compliance specialist?
Have a written agreement that reflects your actual practices
Courts deciding misclassification claims will often focus on the terms of the written IC agreement, especially the company’s right, or lack thereof, to control the way contractors perform services. Recently, the Ohio federal district court decision in Jammal vs. American Family Life Insurance Company emphasized the importance of the written IC agreement.
Be wary of using form agreements that do not accurately reflect the relationship of the parties or outdated documents that do not reflect the current status of the law. Also, your processes should reflect what is in your agreement, and the IC classification must not be undermined or eroded by sloppy compliance. In the American Family Insurance lawsuit, internal company documents referred to ICs as 'employees', which jeopardized the company’s case.
Today, businesses face regulatory and compliance laws at every turn, from cybersecurity compliance to hiring full-time employees. However, ignoring or forgetting about even one of these laws can cause serious harm to a business. As your company considers hiring independent contractors, or even if it is already started hiring them, dive into your IC compliance program to make sure all of your bases are covered.