All businesses must take steps to comply with relevant laws, policies, and regulations in order to operate legally. Compliance takes many forms, from preventing harassment and discrimination, to safeguarding sensitive data and ensuring workplace safety. Enterprises that engage independent talent—contractors, freelancers, consultants, entrepreneurs, etc.—must also abide by a number of these laws and regulations that are specific to these types of workers.
The Difference Between 1099 Independent Contractors and W-2 Employees
To put it simply, different rules apply to independent contractors, because by law independent contractors are a different category of worker than your typical, W-2 employee.
Think of independent contractors as their own business entity. These are people who have built a business around the specialized services they provide. They often perform work for multiple clients, they can openly market their services, and they generally work with a client for a defined period of time to complete a specific project.
Independent contractors are responsible for paying their own taxes and providing their own benefits. Unlike W-2 employees, they do not receive health care options, unemployment insurance, or overtime benefits from a client. Because of this, it can sound enticing to classify workers as independent contractors rather than employees. However, the laws regarding independent contractor classification and contractor compliance are quite strict and complex. Business cannot simply flip-flop workers between the two classifications. In order to be considered an independent contractor in the eyes of the law, a worker must meet a very specific set of criteria.
The Importance of Worker Classification
When a company misclassifies an employee as an independent contractor, it can result in costly legal consequences, audits, fines, penalties, lawsuits, and bad publicity that can lead to customer mistrust. For example, FedEx cut labor costs by misclassifying drivers as independent contractors, resulting in a $228 million settlement for California drivers. Citigroup agreed to a $325,000 settlement for misclassification of technology workers. And human resources software company Zenefits must pay $3.4 million to misclassified employees for unpaid overtime.
Keeping Your Organization Compliant
Government agencies are responsible for ensuring that independent contractors are properly classified, that the right taxes are collected, and that worker rights are protected. To keep your business compliant, it is first important to know the rules.
There are many different standards for determining whether a worker should be classified as an employee or independent contractor, and, unfortunately, these laws can get a bit confusing. Federal agencies including the Department of Labor (DOL) and Internal Revenue Service (IRS) as well as individual states have different laws and guidance documents that must be followed. Become familiar with these agencies and your state laws to make the best contractor compliance judgments.
Next, put a process in place to clearly define worker status. Use written contracts for all independent contractor engagements and make sure your practices are kept up-to-date with changing laws and regulations. Be vigilant—without proper management, it can be easy to misclassify or mismanage workers, which can put your company at risk for audits and penalties.
Consider starting a program specifically for engagement and management of independent contractors. The program should take important factors into account such as your particular industry, and what state laws apply for proper classification of workers. A program can help give you peace of mind, provide legal protection, and make your company an attractive place for independent contractors to work.
Minimizing Future Misclassification Risk
Navigating the large number of changing and often conflicting laws surrounding independent contractor classification is a complex process. That’s why many companies choose to work with a firm that specializes in independent contractor engagement to help them properly assess their existing independent workforce to ensure they are compliantly engaged, paid, and managed. MBO, for example, gathers required classification documentation, vets every independent contractor, and reevaluates them for each new project to ensure an airtight contractor compliance program.
While independent contractor compliance may seem daunting at first, with a bit of work and insight it can become a manageable process. Remain informed about the latest laws and regulations, take contractor compliance measures seriously, and ensure your human capital strategy includes processes to properly classify and engage independent talent.
Have more questions about independent contractor compliance? We’re here to help.
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.