The Risks of Misclassification: 3 Mitigation Tips Every Business Should Know

In June of last year, global delivery giant FedEx settled a decade-long lawsuit involving the alleged misclassification of more than 2,000 drivers in California as independent contractors. The class action lawsuit reached a settlement to the tune of $228 million.

FedEx isn’t the only company under the microscope: Uber, Lowe’s, and Doordash are just a few of the names on the long list of companies that have faced misclassification lawsuits.

If you don’t think this could happen to your company, think again.

Why Is Misclassification Such a Big Deal?

Contingent workers constitute a growing portion of the U.S. workforce. According to the 2015 “Freelancing in America” study, 53.7 million Americans are freelancing, representing 34 percent of the total workforce. The sheer size of the independent workforce has shone a new light on employee classification.

Under current U.S. law, there are two types of classification : “employees,” who are subject to the control of their employer, and “independent contractors,” who are self-employed and run their own businesses. Misclassifying workers as independent contractors  when they should be employees can be a make-or-break scenario for businesses. Getting it wrong can lead to serious tax and employment law violations, with legal judgments and settlements ranging from thousands of dollars to more than $10 million (or in FedEx’s case, $228 million).

However, determining worker classification isn’t always black and white. Depending on the location and the issue at hand – tax, social security, wage/hour, unemployment, workers’ compensation, and so on – there are a myriad of different tests that can be used to determine classification.

Without spending hours studying the nuances of each individual test, how can you be confident you’re engaging your independent contractors compliantly? Here are three steps to help you manage the uncertainty of worker classification and mitigate your risk:

1. Pick Someone Who Chose to Be an Independent Contractor

“It used to be that the American Dream was owning your own home. The American Dream today is owning your own business.” – Keith Hall, President and CEO, National Association for the Self-Employed

Increasingly more and more people are building flexible careers on their own terms, based on their passions, desired lifestyles, and access to broader pools of opportunities. In fact, 60 percent of U.S. freelancers started freelancing by choice, and that number is only expected to grow.

To help avoid classification gray areas when hiring, make sure to select someone who is choosing to be a self-employed independent contractor and actively marketing their services accordingly.

How do you know if someone is an independent contractor? The U.S. Department of Labor  has provided some guidance on what constitutes an independent contractor. By its definition, an independent contractor is “truly in business for him or herself” and “the fact that a worker is in open competition with others would suggest independent contractor status.”

Before awarding a contract, talk to the professional to confirm that they regularly work independently as a self-employed professional or small company, contracting their services out to other businesses and working with multiple clients. This will help eliminate any ambiguity regarding the worker’s classification.

2. Make Sure You Have a Proper Contract in Place

“The most critical factor is communication – making sure both the client and the worker understand the intent of the relationship.” – Keith Hall

When engaging an independent contractor, the best place to start is with a written contract.

The contract should outline the full scope of the project, including project fees, deadlines, and deliverables. The contract should also explicitly state that the  worker is an independent contractor and will have the sole right to determine and control the manner and means by which the work is performed.

As you begin drafting the contract, think through the tasks you’ll be asking the contractor to complete. If you’re asking the contractor to do work an employee would typically perform, you may have a problem. The IRS 20 Factor Test  is a helpful aid in determining whether the tasks assigned are appropriate for an independent contractor.

Your contract doesn’t need to be an extensive form, but it’s important that the key project parameters are clearly laid out up front to avoid miscommunication. Not sure where to start? SHRM offers a helpful contract template. 

3. Choose the Right Compliance Partner

“One of the best things you can do if you’re unsure about proper classification is to get advice.” – Jacqueline Kalk, Esq., Shareholder, Littler Mendelson P.C.

In many situations, the correct classification is clear, but for the 10-20 percent that may be more ambiguous, it helps to have a compliance partner who can determine proper classification.

Before you engage a compliance partner, start by assessing what you wish to accomplish with your contingent worker initiatives. Are you looking to reduce costs? Or struggling to find highly specialized, in-demand talent?

Whether you choose a law firm, accounting advisor, or third-party compliance provider, it’s important that you partner with someone who understands your company’s specific business requirements and the types of workers you’re looking to hire. The compliance partner should also be prepared to address any classification issues and provide details on how they help mitigate risk.

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Classification can feel daunting, but it doesn’t need to inhibit you. By choosing the right contractors, getting a contract in place, and selecting a compliance partner, you’ll be able to engage the best independent talent in the world – without the risk of inadvertently breaking the law.