3 Best Practices To Avoid Misclassifying Employees As Independent Contractors

In the last decade, the rise of the gig economy has fueled an unprecedented increase in the number of independent contractors (ICs) in the U.S. workforce. And that growth has only accelerated in the wake of the pandemic, with more companies relying on remote work arrangements, and many workers laid off during the shutdowns and forced to go solopreneur choosing to remain independent.

In fact, the number of independent contractors in the U.S. workforce rose by 34% in 2021, according to MBO Partners’ 11th Annual State of Independence in America report. As a business owner, using independent contractors in lieu of full-time employees has a number of distinct advantages, including big savings on labor costs, taxes, and training—but using contractors is not without risks.

Along with the rise in ICs, there’s been an equally steady increase in the number of companies being targeted by state and federal agencies for misclassifying workers. And with the election of President Biden, employers are facing even more scrutiny.

Last May, the Department of Labor (DOL) rescinded a Trump-era rule that would have made it easier for employers to designate workers as independent contractors, rather than employees under the Fair Labor Standards Act (FLSA). And as part of his $6 trillion budget proposal unveiled this summer, Biden pledged to end “the abusive practice of misclassifying employees as independent contractors.” To fund this effort, Biden proposed a 12% increase in funding for the DOL’s Wage and Hour Division, which deals with worker classification.

Most recently, in January the DOL and the National Labor Relations Board struck an agreement to collaborate on investigations and share information on potential violations, specifically targeting independent contractor misclassification. The deal will create a new referral process for violations of federal labor and employment laws, making it easier for the government to pursue employers who have breached laws enforced by both agencies.

If you misclassify an employee, you can face hefty fines from the DOL, IRS, and state agencies. Moreover, you can be held responsible for paying back taxes and interest on employee wages, along with FICA taxes that weren’t originally withheld.

You can also be held liable for failing to pay overtime and minimum wage under the FLSA as well as under state laws. Such claims can go back as far as three years if it’s found you knowingly made the misclassification. And if the IRS believes your misclassification was intentional, there’s also the possibility of criminal penalties.

Outside of the fines paid to state and federal agencies, if an employee is misclassified, they’re eligible to claim employee benefits he or she missed out on. These can include healthcare coverage, stock options, 401(k) matches, PTO, and even unpaid break time.

Fortunately, with the support and guidance from us, your Family Business Lawyer™, you can easily avoid these risks and stay totally compliant. While you should meet with us for an in-depth review of your employment agreements and worker classification procedures, implementing the following best practices can go a long way toward ensuring your team members are correctly classified.

1) Conduct An Internal Audit Of Your Classification Process

The first step to ensuring that your ICs are classified properly is to conduct an internal audit of your current classification policies and practices. And if you don’t have any formal policies or practices in place, now is the time to create them.

While the federal government, the states, and the courts don’t have a single common test to determine a worker’s classification, there are some overarching themes that they all consider. In general, if you have the right to control or direct how an IC’s work is done, not just what’s to be done, the worker is more likely to be an employee, not an IC. With ICs, you’re only permitted to direct and control the end result of their work, not the manner and methods of getting it done.

Since there are many complex legal issues related to this process, it’s important that you work with us, your Family Business Lawyer™ to review each worker’s on-the-job practices. Many times an IC’s employment agreement may state one thing, but their actual work performance and relationship with you may be something entirely different.

For example, an IC’s contract might state that they’re to work independently, but in reality they work under close supervision. Or their contract may state that they’re free to work with other clients, but the audit shows that the way you’ve structured the relationship makes it impractical or impossible for them to work for anyone but you.

By auditing your policies and practices in this way, you can identify and change any problem areas internally, before a regulatory agency steps in to investigate.

2) Review And Revise Your Employment Agreements

Even if you’ve worked with someone for years without any problems using a verbal agreement, it’s crucial that every contractor you hire has a properly drafted contractor agreement in place, describing exactly what services the contractor is providing and laying out the parameters of their relationship with you.

We cannot emphasize this point enough: Well-drafted agreements are the foundation of your protection from misclassification. Your IC agreements should clearly define the scope of work, the time frame involved, their communication process with you, and the terms of payment. Additionally, the agreement should clearly state that the worker is responsible for his or her own workplace, equipment, and expenses.

Finally, don't forget to include terms in your IC agreements protecting your intellectual property. This can be done fairly easily using work-for-hire and copyright assignment clauses. To ensure your agreements offer you the maximum protection, be sure to have us review the terms of your agreements, even those prepared by another lawyer.

3) Implement And Enforce Classification

Once you’ve identified and fixed any gaps or areas needing improvement in your IC classification policies and practices, the final step is to make certain these criteria are implemented and enforced. Your policies and agreements are worthless if they’re not actually being followed.

Keep in mind, the DOL, state agencies, and courts are only concerned with what an IC is doing, not what’s in their contract or job description. If necessary, revise your company’s operating manual and procedures to ensure that the provisions of the agreements and policies are thoroughly documented, implemented, and enforced.

Using contractors can give your company an edge in today’s thriving gig economy, but if you’re not careful, they can also be a serious liability. Consult with us, your Family Business Lawyer™ for trusted guidance on the latest worker classification laws, implementing proper classification procedures, and for support in creating airtight agreements that protect both your company and your intellectual property. Contact us today to schedule your appointment.

This article is a service of a Family Business Lawyer™. We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Call us today to schedule.

We offer a complete spectrum of legal services for business owners and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer you a LIFT Your Life And Business Planning Session, which includes a review of all the legal, insurance, financial, and tax systems you need for your business. Schedule online today.