Three strategies to reduce the risk and potential fines associated with worker misclassification.
By Dana Shaw
Has the worker classification world gone mad? As if economic and governmental issues weren’t challenging enough, the blame-and-shame game for companies who misclassify workers, even unintentionally, has hit an all- time low. Consider the most recent conflicting headlines, HR blog posts, and messaging from state departments:
• “Supreme Court declines to hear challenge to Illinois employment law.”
• “More firms will hire contractors by 2020.”
• “$10.2 million awarded to fund worker misclassification detection, enforcement activities in 19 state unemployment insurance programs.”
• “Does Silicon Valley have a contract-worker problem?”
Then there’s Pennsylvania’s Construction Workplace Misclassification Act that outlines a summary offense in § 933.5. as “An employer, or officer or agent of an employer, that negligently fails to properly classify an individual as an employee under section 4(a) commits a summary offense and shall, upon conviction, be sentenced to pay a fine of not more than $1,000. Evidence of a prior conviction under this subsection shall be admissible as evidence of intent under subsection (a).” It’s enough to make your head spin.
How confident is your organization in determining worker misclassification and the costs associated when getting it wrong? In a recent survey from ICon Professional Services, nearly 70 percent of organizations had great confidence in passing an audit, yet according to the government, only 55 percent report actually passing. Some additional haziness in this critical area:
• Only 57 percent of respondents report they have great confidence in knowing the exact number of independent contractors they are currently using, increasing overall risk exposure.
• Seventy-seven percent of respondents believe their total financial risk exposure to failing a worker misclassification audit is below $100,000. The reality is that for 100 independent contractors paid on average $100,000 annually, a company’s financial risk could exceed $4.5 million.
Many misclassification cases are settled privately and remain out of the public domain, which makes it even more difficult for senior executives to understand their total risk and the significant costs associated with misclassification.
Independent Contractors—and More Risks—on the Rise
When it comes to the overall contingent workforce landscape, ICon’s survey reveals that independent contractors play an increasingly important role in the labor market:
• Eighty-four percent of respondents said they would maintain or increase their investment in independent contractors in 2015.
• Half (50 percent) of those surveyed utilize up to 20 independent contractors per year, while 30 percent engage up to 100 per year. Fifteen percent utilize more than 500 contractors per year.
• The largest proportion of respondents (37 percent) retains their relationship with contractors for up to a year, while almost a third (28 percent) engage them for up to three years.
• Nearly seven in 10 respondents use independent contractors because of their unique specialist skills.
As demand for independent contractors grows, legislation continues to evolve as states and the Department of Labor/IRS try to get a handle on this workforce segment. Constantly changing regulations can create a risky environment for businesses of all sizes, especially those in the Fortune 2000 that leverage large numbers of independent contractors. Be sure to arm yourself with the appropriate knowledge to avoid fines associated with worker misclassification.
What determines an independent contractor versus a full-time employee is an overall picture of behavioral, financial, and relationship factors? What does an independent contractor look like?
• Receives a “1099” form for tax purposes versus a W-2;
• Typically works as an individual;
• Often referred to as a consultant or freelancer;
• Paid through purchase orders or accounts payable processes; and
• Any non-employee that does not have taxes withheld per pay period.
Once you have a general sense of what defines an independent contractor, it’s imperative that you go a step further. This means properly classifying these workers through a series of criteria that determine the degree of control and independence that is at play. Often, this involves leaders from a number of different departments within an organization, including the CEO, CFO, CHRO, general counsel, and contingent workforce program director.
Proper independent contractor classification should include these three factors:
1. Behavior control. This area of classification is based on whether or not a company is directing or controlling how a worker does their actual work. Behavior control factors fall into the below categories:
• Training and instructions;
• Hours of work;
• Location of work; and
2. Financial control. For this particular focus area, companies must ask themselves whether or not they have the right to control the economic parts of a worker’s job with their organization. This can include a wide variety of considerations:
• Significant investment;
• Paid by the job;
• Own tools and equipment;
• Worker’s services are made available to the general public;
• Business expenses; and
• Profit or loss on a job.
3. Relationship of the parties. The big question here is: How do the worker and business view their relationship with the other? Is there a written contact? What types of benefits does the worker receive? Is the worker at the core of the business? Organizations should review:
• Intent of the parties;
• Termination – what is the permanency of the arrangement?;
• Firm’s core business;
• Benefits provided; and
• Liable for breach.
To minimize financial risk and gain a clear understanding of how significant that risk may be, businesses must take all of these factors into consideration. Sometimes, the case is cut and dry whether or not a worker is an employee or independent contractor. More often than not, though, a few factors will point to a worker as an employee, while others will declare them an independent contractor. This gray area can be tricky to navigate. Especially because, according to the IRS, “there is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.”
As businesses continue to leverage the contingent workforce alongside constantly changing classification parameters, there will inevitably be challenges, roadblocks, and hurdles. The key is to shine a light on these issues so that the reality is clear and murky perceptions are cast aside. Then, companies can move forward in ensuring that they are taking the steps necessary to fully harness the power of the labor market.
Dana Shaw is chief operating officer of ICon Professional Services. She leads the development and execution of ICon’s product and service strategy, partnerships, worldwide sales, marketing, and day- to-day operations.