The Misclassification of Independent Contractors

In industries with high populations of independent contractors (IC’s) there is uncertain risk that many businesses may not be aware of. There has been a 300%-750% surge in criminal investigations, business audits and arrests by federal agencies over the last two years due to the misclassification of IC workers. The IRS defines an independent contractor as: “a worker who individually contracts with an employer to provide specialized or requested services on an as-needed and/or project basis. This individual is free from control and direction of the performance of their work, and the individual is customarily engaged in an independent trade, occupation, profession or business.”

Who is watching and enforcing misclassification violations?

While some employers make an error when workers are misclassified as independent contractors, some workers are misclassified as independent contractors in an attempt to reduce labor costs and to avoid the payment of state and federal taxes. At least 19 states, including New York, Massachusetts, Michigan, New Jersey, and Iowa created inter-agency task forces to study the magnitude of the problem and coordinate and strengthen enforcement mechanisms. In 2019 three states launched new initiatives to crack down on employee misclassification: Michigan‘s Attorney General Dana Nessel established a new Payroll Fraud Enforcement Unit; Wisconsin’s Governor Tony Evers signed an executive order to form a Joint Enforcement Task Force on Employee Misclassification;and Montana’s Governor Steve Bullock issued an executive order to create a Task Force on Integrity in Wage Reporting and Employee Classification. It is expected that other states may follow suit.  According to an article in Independent Contractor Vs. Employee: What’s The Difference? “There are a number of factors to consider when determining worker classification, but all federal and state factors need to be taken into consideration when deciding. Ultimately, the burden of proof is on the employer, and you should consider what is more beneficial for the employee, not the employer, when making this important decision.”

“Many businesses simply overlook (or are unaware of) the IC compliance regulations required for IC classification. There are many examples of companies that misclassify employees and get audited by the DOL because of complaint filings or federal filings. With legislative environments becoming increasingly complex, the correct classification of employees is critical. The best way for companies to be ready for unexpected audits is to have a system in place to provide the proper reports and documentation supporting the classification of their employees. ” – Ben Olson, CEO of Essium, LLC

So, what can a company do to meet IC compliance requirements?  

  1. Partner with an IC Compliance Service Provider: The complexity associated with gathering the appropriate proof documents to withstand an audit is a daunting task.  Companies with multi-state locations may face an additional challenge as state and local requirements may vary. The task of instantiating compliance can be difficult to navigate.  
  2. Perform an Internal IC compliance audit: Some companies choose to perform their own internal compliance audits.  This can happen if they have the right resources and the right employees with a skill set to perform the audit. This can be a daunting task depending on the size of the company. 
  3. Implement IC Compliance Software: The right software system can automate many tasks required to perform IC compliance audits. A comprehensive system can provide:
  • A list of IC requirements by state
  • The ability to upload and verify documents within the system
  • Electronic records and documentation 
  • Reporting functions to provide documentation to IRS during an audit

According to a paper published by two Harvard Law School Labor and Worklife Program students: States have been involved in combatting misclassification and payroll fraud for many years. The first statewide inter-agency task force on misclassification was created in New York in 2007. Indeed, some of the worst consequences of misclassification – failure to pay unemployment insurance contributions and to procure workers’ compensation insurance – have the greatest impact on the state level, where those programs are administered. Over the past two decades, many states have taken considerable measures to root out and stop misclassification and payroll fraud. It should also be noted that companies choosing to perform an internal verification process should utilize the services of employment legal counsel when the IC verification process is underway. 

Which ever way a company chooses to get there, it is important that businesses spend time and resources to verify their IC worker classification to reduce risk and ensure long-term compliance for their workforce.