How Worker Misclassification Impacts Independent Contractors

By MBO Partners | September 7, 2022

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Key Points

While some misclassification is unintentional due to lack of understanding about laws regarding worker classification, sometimes it is done deliberately to reduce labor costs, and avoid paying state and federal payroll taxes.

Defining whether or not a worker is an independent contractor or an employee is not a straightforward question.

When workers are misclassified, they miss out on important workplace protections such as the right to join a union, minimum wage, Unemployment Insurance (UI), workers’ compensation, and overtime.

As the 64.6 million-strong independent workforce continues to grow, so does the issue of employee misclassification.

The IRS estimates that millions of workers have been misclassified, and according to state-level studies, 10-30% of employers misclassify their employees as independent contractors. While some misclassification is unintentional due to lack of understanding about laws regarding worker classification, sometimes it is done deliberately to reduce labor costs, and avoid paying state and federal payroll taxes.

High-profile lawsuits involving Uber, FedEx, Zenefits, Citigroup, and more have thrown the issue of misclassification into the spotlight. Unfortunately, misclassification truly affects everyone—business owners, workers, and the government—and occurs in nearly every sector of the economy from banking and financial services, to manufacturing, health care, and entertainment.

In this series, we’ll explore the cost of misclassification on businesses, independent contractors, and the government.

Why is worker classification so complicated?

Defining whether or not a worker is an independent contractor or an employee is not a straightforward question. If you dig into the nuances of the laws, tests, and guidelines surrounding independent contractor classification, it quickly becomes apparent that they differ from one to the next and can be interpreted in a variety of ways. A worker could be seen as a contractor from one perspective, but as an employee from another.

The impact of misclassification on contractors

Despite these complications, the fact remains that independent contractors cannot be treated or engaged like traditional W-2 workers. While there are many benefits to engaging independent professionals—access to specialized talent, financial incentives, the ability to secure expertise on a per-project basis—when organizations classify workers as contractors simply to lower payroll taxes, numerous problems arise.

When workers are misclassified, they miss out on important workplace protections such as the right to join a union, minimum wage, Unemployment Insurance (UI), workers’ compensation, and overtime, and they may be ineligible for company-provided benefits such as health insurance, retirement funds, or stock options.

While many workers choose to be independent for the flexibly and autonomy it provides, if they are mistakenly or purposely misclassified, they are often left with lower incomes and little economic security.

How to reduce the risk of worker misclassification

Luckily, there are many things organizations can do to avoid misclassifying workers. First, it is important to be aware of independent contractor rights, and what differentiates an independent contractor from an employee. As a general guideline, independent contractors should be engaged to complete a specific project with clearly defined success metrics and a start and end date, contractors should maintain control over when, where, and how they work, and contractors should not perform the same work as employees.

In addition, it is also helpful for businesses to conduct an internal audit of current classification processes, educate HR and hiring managers on classification practices and laws, use a written contract for all independent workers engaged, and form a cross-function team to handle any misclassification issues that arise.

The best thing businesses can do, however, is to partner with an organization that specializes in independent contractor engagement and compliance. The compliance process is complex—it goes well beyond indemnification and adhering to classification laws and guidelines—and most online marketplaces and staffing firms are not fully equipped to handle the extensive investigation and ongoing support that compliance requires.

MBO Partners has an established methodology in place for evaluating and engaging independent workers, and facilitates additional compliance tasks such as ensuring contracts are fairly written and negotiated, taxes are accurately withheld and paid, and eligible expenses are correctly submitted and deducted.

To learn more about how you can minimize misclassification risk, contact us today.

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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