What Is Worker Misclassification? The Compliance Risk Most Companies Underestimate

Worker misclassification is far more widespread—and financially damaging—than most business leaders realize. The National Employment Law Project reports that between 10% and 30% of U.S. employers incorrectly classify employees as independent contractors, affecting millions of workers across industries and regions.  

Similar co-employment issues exist worldwide, with many countries grappling with the risks and consequences of misclassification. 

The financial consequences are staggering. Consider these real-world examples: FedEx paid $228 million to settle a single California misclassification lawsuit involving just 2,300 drivers. Meanwhile, two Massachusetts construction companies faced $2.36 million in fines for misclassifying 400 employees.  

These aren’t one-off events: They’re cautionary tales for any organization that works with independent talent. 

Understanding the Basics: Employees vs. Independent Contractors

Proper classification comes down to one fundamental question: Who controls how the work gets done?

Employees work under your direction. Your company doesn’t just define the desired outcome—you also control the day-to-day details of how work is performed. Employees follow your processes, use company-provided tools, work set hours, and take direct instruction from your managers on both what to do and how to do it.

Independent contractors operate autonomously. These professionals—whether freelancers, consultants, or specialized experts—are hired specifically for their expertise and experience. They manage their own workflows, provide their own tools and equipment, set their own schedules, and determine the methods for delivering agreed-upon results. You can specify what you need accomplished and set quality standards, but dictating how they achieve those results crosses into misclassification territory.

The distinction matters because it reflects the fundamental nature of the relationship. Employees are integrated into your business operations and work under your ongoing supervision. Contractors function as independent businesses providing specialized services on their own terms.

Learn More: W-2 Employee vs 1099 Independent Contractors: Pros and Cons 

Why Worker Classification Gets Complicated

Classifying workers isn’t always straightforward. What qualifies someone as an independent contractor under one law might make them an employee under another. Different jurisdictions have different tests and standards—and that inconsistency can create serious issues. 

For businesses, the risks of getting it wrong are real: 

• Hefty financial penalties that can reach into the millions 
• Lengthy legal battles that drain time, energy, and focus 
• Reputation damage that can affect customer trust and your ability to attract top talent 
• Costly back payments for unpaid taxes, wages, and benefits—with interest 

The bottom line: A simple mistake of misclassification can ripple through your business in ways you didn’t expect. 

Discover: The Impact of Worker Misclassification on Your Company’s Credibility 

Building a Strong Workforce Compliance Program

Creating a strong contractor compliance program protects your business and sets you up for long-term success. Focus on these essential components:

Establish a Solid Legal Foundation

Stay current on federal, state, and local employment laws—especially if you operate across multiple regions or countries. Regulations change frequently, and keeping up helps you avoid costly surprises down the road.

Document Clear Policies and Procedures

Transform legal requirements into practical guidelines your teams can actually use. Your internal policies should outline:

• How to properly engage and onboard new contractors
• Best practices for managing ongoing working relationships
• Procedures for ending contracts when projects conclude
• Required documentation to collect, store, and retain

Invest in Ongoing Training

Your internal teams need more than a list of rules—they need to understand the reasoning behind them. When employees grasp the real business consequences of misclassification, including financial penalties and legal exposure, they’re far more likely to stay vigilant and follow proper protocols.

Conduct Regular Compliance Audits

Contractor relationships evolve over time. A properly classified project-based role can gradually shift into something that looks more like employment. Schedule periodic reviews of your contractor arrangements to identify changes before they become compliance issues.

Explore: 3 Benefits of Creating a Compliance Program for Your Organization  

The Value of Expert Talent Solutions Partners for Contingent Workforce Management

Even with a strong internal program, you don’t have to manage classification risk alone. As your contractor needs grow more complex, partnering with an experienced talent solutions provider adds an extra layer of protection. This partnership brings both peace of mind and practical support when you need it most.

Organizations like MBO Partners offer: 

Proven Systems and Processes

These platforms are built specifically for contractor engagement, not retrofitted from other purposes. From classification checks to documentation tracking and risk assessments, these tools help you stay organized and compliant. Everything you need lives in one place, making oversight simpler and more reliable.

Expert Guidance

You’ll work with teams who have compliance experience. They’ll help you navigate shifting regulations, work through challenging classification decisions, and ensure you’re on solid ground. Think of them as an extension of your team—experts who’ve seen it all and know how to help.

Structured Contractor Relationships 

The right partner helps you build contractor relationships that are productive, professional, and legally sound. They’ll show you how to maintain clear boundaries with contractors while still capturing the full value of their skills and expertise.

Scalable Solutions

As your business grows or expands internationally, your workforce strategy needs to scale with it. An experienced partner helps you grow without creating new risk exposures or losing consistency across engagements. What works for 10 contractors will also work for 100—or 1,000.

Cost Savings

Beyond risk mitigation, the right partner delivers real ROI through penalty avoidance, reduced legal exposure, and streamlined operations. You gain quick access to specialized talent while your internal teams focus on strategy instead of compliance details.

Case Study: Big 4 Consulting Firm Saves $6M With Contractor Compliance Strategy

MBO Partners Supports Your Workforce Compliance Efforts

The way we work is changing, and getting classification right is more important than ever. Investing in compliance doesn’t just protect your business. It lays the groundwork for long-term success with a workforce that’s agile, skilled, and ready to meet the moment. 

For more information on contingent workforce management and the benefits of working with independent contractors, visit our resource center for insights on workforce compliance, contractor engagement strategies, and the latest technologies shaping the future of work. 

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.