There are a number of common traps that can cause problems for companies who aren’t careful when engaging independent workers. Perhaps the most common is engaging a worker as an independent contractor when they and/or their project really didn’t support that status.
Let’s be honest, at one time or another almost every organization has engaged a contractor (often referred to as a consultant, freelancer, IC, gig worker, etc.) who insisted on being treated as an independent contractor (IC) when in reality they weren’t qualified to be engaged under that designation. The most common scenario is the independent worker who absolutely insists the only way they will work for the client company is as an IC, and the engagement manager supports the decision.
Every company does what they believe is necessary to get the work done, and in many cases it turns out fine. However, sometimes companies come to regret the decision to misclassify a worker as an independent contractor. The risk is always there, but often doesn’t rear its ugly head until after the project is over. Sometimes this can even happen two or three years later.
Here is a very common scenario:
- The worker, who at the onset of the project insisted on being classified as an independent contractor, applies for unemployment benefits after they are unable to secure another project. The consultant learns an inconvenient truth from the local unemployment office: only ex-employees (not ex-ICs) are entitled to unemployment benefits. At this point the contractor’s perception of the project might begin to change.
- The consultant argues with the unemployment office, and a sympathetic caseworker (who really wants to help the former consultant receive benefits, since that’s their job) begins asking questions. Were they really an IC? How was the project structured? Was there anything in the relationship that could be construed as an employee/employer relationship? Etc.
- The issue is then referred to a state employment tax audit office to verify the worker status. In the meantime, the former contractor will likely be paid unemployment benefits since most government agencies assume every worker is an employee. They assume the worker was misclassified unless the client can prove otherwise.
- At this stage things can begin to snowball for the client company. When the state tax auditor receives the assignment, a formal information gathering process begins:
- Their goal is to verify the correct worker status of the former consultant. They will look at the work and worker to determine if this was, in fact, a defensible independent contractor working arrangement, or if this worker really should have been classified and treated as an employee.
- The auditor will also arrange a tax audit to review all potential misclassified workers in the company — not just the consultant who filed a claim
The result of this audit process is that the company may now need to prove every IC engaged during the statutory period (normally looking back three years) was properly classified. This common scenario results in thousands of tax audits each year.
Other facts to consider are:
- The contractor applying for unemployment benefits is no longer loyal to the company, because they now need the income for their daily living expenses and their perspective has most likely changed as a result.
- The engagement manager who supported the original misclassification decision because they needed to get vital work done may have moved on and is not available to provide details about the working relationship.
- Even if there are still people at the client company who remember the details of the project, their memories have likely faded, the most important details are about the day-to-day working relationship during the time of the project.
- Most government agencies have a bias towards protecting workers, not employers. They assume every worker is a non-exempt employee unless the employing company can prove otherwise. As a result, the auditor will give the former contractor’s version of the working relationship more weight than the company’s, unless the company has some very convincing evidence.
- The primary evidence most client companies have is typically a written contract. Most of these contracts attempt to predict what is going to happen in the future, while the auditor is looking at what actually happened in the past. In addition, written contracts rarely provide the level of detail required to resolve a classification issue.
- Statistically, more than 70% of employment tax audits result in a finding of misclassified workers. One reason for this high rate is that the burden of proof is on the business to prove it acted correctly, not on the government to prove its tax assessment is correct.
Similar worker misclassification challenges can also result from a number of other common scenarios. For example:
- A consultant is injured on the job, and files a workers comp claim.
- A consultant alleges unjust treatment, and files an EEOC claim.
- The consultant claims entitlement to employee fringe benefits
In each of these cases, the contractor may tell the tax auditor, attorney or a judge that they accepted the project on an independent contractor basis because they felt it was the only way to get work. Most federal and state enforcement agencies refer to this as an adhesion contract and use it as evidence there was direction/control from the employer’s side. Usually, they find that the contractor in question was in fact a misclassified employee.
The best way to prove your independent contractors are properly classified is to have an expert, like TalentWave, qualify each independent worker and their project, and then secure and maintain the proper audit-defense file documentation from the project’s inception. Since our inception we’ve performed over 50,000 IC qualifications and have never had a decision overturned.