Independent Contractor Compliance: 4 Things Companies Need to Know

Independent contractor compliance requires organizations to properly classify, engage, and manage independent workers according to applicable federal, state, and local laws. Because independent contractors are legally different from employees, organizations must follow different rules when working with this talent population. 

 Here are four things companies should know about independent contractor compliance. 

1.  Independent Contractors vs. Employees: Classification Matters 

Independent contractors and employees are legally distinct worker classifications, which means organizations must engage and manage them differently. 

One of the most important things to be aware of is when to classify a worker as an independent contractor and when to classify them as an employee. This is not a choice that can be left to the discretion of a client or employer—there are specific federal, state, and local laws that govern whether a worker can be considered an independent contractor or employee. Confusingly, however, because there is no universal definition of “independent contractor,” there is a lot of ambiguity with these laws. Depending on how they are interpreted, a worker could be seen as an independent contractor from one perspective and as an employee from another.

Independent contractors operate as their own businesses and are generally responsible for their own taxes and benefits while maintaining greater control over when, where, and how they perform their work.  

2.  Independent Contractor Compliance Is an Ongoing Challenge 

Independent contractor compliance is an ongoing challenge because worker classification requirements can vary by law and jurisdiction and continue to evolve. Federal worker classification guidance also continues to evolve, making ongoing monitoring important for organizations that engage independent contractors. 

Independent contractors cannot be engaged or treated like traditional, W-2 employees. Misclassification, whether willful or not, can lead to weighty consequences including fines, negative publicity, penalties, and class-action lawsuits.

A centralized independent contractor compliance program helps organizations apply classification and engagement processes consistently across departments and reduce misclassification risk. Remember, even if certain departments or managers within your company have a system in place to engage independent contractors, without an overarching centralized program, true risk management can be difficult to achieve.

3.  Worker Misclassification Can Have Significant Legal and Financial Consequences 

Worker misclassification can expose organizations to audits, back taxes, fines, penalties, and other legal and financial consequences. The IRS may become involved in worker classification questions in several ways. For example, a worker or business may file Form SS-8 to request a worker-status determination, a worker may receive both a 1099 and W-2 from the same company, or an independent contractor may file for unemployment or disability benefits. 

If you do misclassify employees, you may be violating wage, tax, and employment eligibility laws. Resulting fines from the U.S. Department of Labor (DOL), IRS, and state agencies can total millions of dollars. Companies can also be held responsible for paying back-taxes on employee wage interest as well as FICA taxes that weren’t withheld originally.

4.  Independent Contractor Programs Require Comprehensive Compliance 

A comprehensive independent contractor compliance program should address risk throughout the contractor lifecycle, from sourcing and classification through engagement, management, payment, and re-engagement. The level of compliance review and oversight may need to increase as the value, duration, or complexity of an independent contractor engagement grows. When developing a program, it is important to factor compliance into all aspects of the independent contractor lifecycle, from sourcing and engagement, to management and future re-engagement.

Creating a program that addresses all of these needs can be a big task to take on. That’s why many organizations decide to partner with a firm like MBO that offers flexible engagement models to account for the different levels of self-employability that independent contractors bring to the table and has a tried and proven methodology for independent contractor engagement.  

A strong independent contractor compliance program helps organizations reduce worker misclassification risk while creating consistent processes for engaging and managing independent talent. As classification requirements continue to evolve, having the right expertise, policies, and controls in place can help organizations remain compliant while taking advantage of a flexible workforce. 

Frequently Asked Questions About Independent Contractor Compliance

What is independent contractor compliance?
Independent contractor compliance means properly classifying, engaging, and managing independent workers according to applicable federal, state, and local laws and regulations.

Why is independent contractor classification important?
Proper classification helps organizations determine whether a worker should legally be treated as an independent contractor or an employee. Misclassification can expose a company to taxes, penalties, audits, and legal claims.

What is the difference between an independent contractor and an employee?
Independent contractors operate as their own businesses and generally maintain greater control over how they perform their work, while employees typically work under greater direction and control from an employer.

What are the risks of independent contractor misclassification?
Worker misclassification can result in audits, back taxes, unpaid employment obligations, fines, penalties, lawsuits, and reputational damage.

How can companies reduce independent contractor compliance risk?
Companies can reduce risk by establishing consistent worker-classification processes, keeping current with applicable laws, educating managers, documenting contractor relationships, and using a centralized independent contractor compliance program.

The information provided in the MBO Blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO Blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.