How to Avoid an Misclassification Audit

By MBO Partners | March 6, 2020

consultants working in office

Today, there is a growing awareness of independent contractor rights, high-profile employee misclassification lawsuits, heightened scrutiny from government agencies, and more frequent use of independent contractors. These changes have led to an increase risk of being audited for worker misclassification.

If your company engages independent contractors, temporary workers, remote workers, or freelancers, it is important to understand that these workers cannot be engaged or treated like traditional W-2 employees. Doing so risks an audit, which can lead to many negative consequences including large fines, bad press, back tax payment, stalled acquisitions, and class-action lawsuits.

Companies of any size and reputation are subject to audits. A number of activities can trigger an audit including a contractor who files for unemployment, a whistleblower who reports possible misclassification, or a worker who files an SS-8 form to request classification determination.

Minimize the risk of a misclassification audit with these five tips and improve independent contractor satisfaction at your company.

1. Review Current Worker Classification Practices

Conducting an internal audit is a valuable practice that can provide you with an in-depth understanding of your current classification practices and whether or not they are compliant. To conduct an audit, gather records of services performed by contractors, check to see if you have contracts on file for your independent engagements, and confirm if the contractors you’ve engaged in the past have federal tax ID numbers.

Are you able to prove that all of the contractors you’ve engaged qualify as independent workers? Investigating your practices can help identify gaps and areas for improvement before a regulatory agency steps in with an audit of their own.

2. Consider Developing a Centralized Program for Independent Contractor Engagement

Your business may have a worker classification policy in place, but do employees consistently follow it? If not, you could be at risk. Work with your HR team or hiring managers to develop a centralized program for engaging and managing your independent workers. Program policies should be understood and enforced across the board, and have the flexibility to evolve as needed. Consider possible barriers to implementing a program, and develop strategies to overcome obstacles for a smoother adoption process.

3. Ensure Independent Workers are Properly Classified

The federal government, state government, and government agencies all apply different laws and tests to determine worker classification. These tests lack uniformity, so just because a worker complies with one test, doesn’t mean they’ll comply with another. While this complicates the vetting process, it is still important to be aware of these laws when assessing the classification status of workers.

In general, it is good practice to keep records of documents that support a classification decision such as a business or professional license, business cards, or insurance certificates that can be used as proof of self-employment.

4. Require Hiring Managers to Use a Written Contract

Using a written contract for all independent contractor engagements not only helps to clearly define your working relationship, but it also helps to verify classification in the event of an audit. In addition to outlining the scope of work, defining the communication process, and specifying payment terms, you may want to consider including additional safeguards such as explicitly stating the person you’re engaging with is an independent worker, that they are free from control, and that they have insurance.

5. Build a Cross-Functional Team for Support

A cross-functional team keeping an eye out for warning signs can save you a big headache down the road. If possible, include representatives from legal, compliance, HR, and procurement to provide insight and support from different perspectives. This team should be on the lookout for audit triggers such as independent workers filing for worker’s compensation, disability, or unemployment claims as well as ensure that contractor hiring and management processes stay compliant and up-to-date.

While there are many things you can do to minimize the risk of a misclassification audit, independent contractor engagement can be a confusing and tricky road to navigate. Firms like MBO Partners have an established methodology in place for evaluating and engaging independent workers for clients and have proven best practices for minimizing or eliminating issues with contractor engagement. Partnering with a company that specializes in independent contractor engagement and compliance can help minimize your risk and make sure your business remains compliant.

To learn more, download our guide: How to Deal with and Avoid an Employee Misclassification Audit.

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.  

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