3 Key Factors of Classification Compliance

By MBO Partners |

Updated Tuesday, October 20, 2020

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Self-employment is now a viable career option for more people than ever before. Enterprises need the flexibility independent contractors can provide and their skillsets are in high demand. Independent talent can give businesses a cutting edge by providing on-demand expertise, financial savings, and staffing flexibility.

However, as the use of independent talent grows, businesses must also adjust the way they manage their workforce—compliance goes hand-in-hand with independent contractor engagement. Without proper management of independent contractors, you can run the risk of worker misclassification, which can lead to audits, fines, penalties, lawsuits, and more. Here are three important things businesses should know about independent contractor compliance.

1. Worker Status is Complex and Changing

From a legal standpoint, a worker must meet a specific set of criteria in order to be considered an independent contractor. There are many different federal, state, and government laws and regulations regarding worker classification, but because there is no single definition of what makes a worker an independent contractor, much is left up to interpretation when it comes to these laws. Not surprisingly, this leads to a lot of confusion when trying to classify workers.

Even so, it is important for organizations to follow federal, state, and local laws as closely as possible in order to minimize their exposure to misclassification liability. Because worker classification can be so complex, many organizations decide to work with a third party to help reduce engagement risk and ensure proper classification.

2. Degree of Control Is Crucial

Degree of control is one of the many differences between engaging an independent contractor and hiring an employee. When you engage an independent contractor, you are starting a business-to-business relationship. Independent contractors are tasked with managing both the process and outcome of their contract; how they conduct the work needed to produce the agreed-upon results is entirely up to them.

For example, independent contractors decide where, when, and how they conduct their work. They are free to openly market their services and may take on work for additional clients even when working on a project for your company.

3. Worker Misclassification is Costly

Correctly classifying workers is important because employers are not responsible for providing common benefits such as health care options, unemployment insurance, or minimum wage to independent contractors. Typically, misclassification stems from the economic and business advantages of using independent talent, combined with the grey area of competing legal guidance (as described above).

If the IRS finds that your business has misclassified workers, you may be liable for paying fines and penalties, or find your company caught up in an expensive lawsuit. Not only can misclassification hurt your finances, but it can also damage the long-term reputation of your company if negative publicity leads to customer mistrust.

One of the best ways to remain compliant is to have a program in place for engaging and managing independent contractors. A program will account for laws applicable to your particular industry and state, outline company-wide policies and procedures, and put legal safeguards in place to minimize misclassification risk. Firms like MBO specialize in independent contractor engagement can create a personalized program for your organization, providing peace of mind, legal protection, and making your company an attractive place for independent contractors to work and return to work in the future.

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.