WORKER CLASSIFICATION

If you’re looking to bring on some independent contractors or employees to help you accomplish your goals for 2023, you better have worker classification on the mind. How you classify workers affects what paperwork they’ll need as well as how you’ll pay them, what benefits they’ll be entitled to and how/when they execute their responsibilities. The IRS is paying close attention to how employers classify workers and it’s worth thinking about up front to prevent issues later.

What’s The Difference Between an Employee And an Independent Contractor?

Much of the difference between the two comes down to control. While the employer determines what they want done, independent contractors control how and when they accomplish the tasks. They have a lot of flexibility and they are usually not entitled to company benefits. Since they are often hired on a project basis, it usually requires less up-front training to bring them up to speed. Independent contractors are appropriately named because their working arrangements and goals are stipulated in a mutually-agreed upon contract. Contractors pay for their own self-employment taxes, payroll taxes, and benefits.

Employees, on the other hand, are subject to the employer’s stipulations for when and how a worker accomplishes their tasks. Employees usually take more time to train and bring up to speed and also cost more overall because they are entitled to benefits such as 401Ks, health insurance, overtime, and more. Beyond federal requirements, you may be required to offer additional benefits like dental and vision insurance, paid time off, disability, and more. Aside from the costs of payroll, the actual process requires an investment, too. At a minimum, you need payroll software and sometimes it requires a whole department to manage the logistics of such a complicated process.

Employees tend to have a large up front learning curve, but it flattens out because they don’t need to be retrained for the same ongoing tasks. You may also end up paying for recruiting and professional development costs for internal staff.

When Should I Hire an Employee Versus an Independent Contractor?

While it may look like an employee always costs a company more, it isn’t always true. Contractors often charge a premium rate since they are paying for their own benefits and the very best ones can justify top dollar for their services. Still, costs are only one part of the equation. When you’re considering whether to hire an independent contractor versus a full-time employee, you should consider what kind of work you want done.

Independent contractors are great for short-term projects, specialized creative tasks, seasonal needs, and work that is beyond your core business. Independent contractors are great for things like building a new website, designing marketing materials, and handling administrative tasks.

Employees are best when the company needs to be able to stipulate when, where, and how the work gets done or when the work is long-term and ongoing. If the work is central to your core business, think twice before you classify workers as independent contractors. The companies that end up in the news are often the ones that call the workers at the core of their business contractors. Think Uber and Instacart–which have fought to maintain that their drivers are contractors even though their work is central to their business.

The Bottom Line

Which type of worker makes sense—both for your business in general, and for each individual role you need filled—depends on many factors. No matter who you bring on, one of the most important things you can do to protect yourself is classify them correctly. If you are trying to determine how to classify your workers, this 5-minute self audit may help. You may also wish to have a conversation with one of our experts if you need more support.

Employee misclassification is becoming an increasingly big deal for government and an equally bum deal for businesses that don’t take it seriously enough. Back in 2000, Microsoft paid $97 million, plus legal fees, in a benefits dispute with its long-term temps. More recently, FedEx shelled out $228 million. Of course, there’s also Uber, which has been in multiple disputes, including over whether drivers were independent contractors (as Uber maintained) or employees (as the law determined).

In short, this stuff matters.

10 Moves That Increase Your Likelihood of Ending up in Hot, Expensive Water.

1. Letting Contractors Determine Their Own Classification

Businesses have the burden of responsibility here. Do your due diligence with each worker to determine their status and whether they are contractors or employees. Subsequently, this will determine whether they should be paid via W2 or 1099.  If you need support, our worker classification quiz can help you sort out where your workers stand. When in doubt, engage a partner with the expertise to guide you through it. It’s worth investing whatever time, attention, and costs needed to do it right. 

2. Failing to Stay on Top of Regulatory Changes

Similar to the above, if the law says it’s not okay, you will be held accountable—no matter how long you’ve done it without problems. “We’ve always done it this way” simply does not hold up as a viable defense. The best way to manage this is to have someone available to dedicate the resources and time to researching and monitoring all legal changes or to engage a partner who is doing all of that for you. You can determine which is right for you based on how often you have hiring needs and whether it’s worthwhile for you to dedicate internal resources to the task or to outsource it.

3. Failing to Properly Insure Workers

Insurance always represents a bit of a gamble. You may never end up using it, in which case, the cost can seem pointless. On the other hand, when something goes wrong, it can be the difference between a minor inconvenience and the end of your business. You’ll be glad you took the extra effort and had the backup insurance in place. That goes double when there’s a lot of expensive equipment around.

4. Thinking Hiring an Agency Ends All of Your Risk

Engaging a partner company with the right expertise is hugely beneficial and will help ensure that your business is on the up and up. But, co-employment risk still exists. It’s still in both you and their best interest to know and implement the rules around worker classification.

5. Following The Industry Practices

Take a lesson from sibling dynamics here: The kid who gets caught doing the crime does the time—even if the sibling does it all the time undetected. Just because you and your associates haven’t been caught with misclassified workers doesn’t mean you won’t be eventually. Follow the laws, adjust as they change, and you’ll be able to sleep well at night. 

6. Downplaying The Risk

The government has a lot of money at stake here. It’s in the news a lot for a reason and it’s not going away. Don’t ignore the rules because the government isn’t ignoring them either. If you think they’re not coming for you and get lackadaisical, it will eventually catch up with you. 

7. Assuming Day Rates Are Compliant With The Law

Although common in many industries, day rates aren’t always as simple as they seem. It takes a lot of time and a complex system to monitor day rates and other compliance loop holes in every city and state. Someone on your team needs to be paying attention or you need to have a partner that is.  

8. Overlooking Details of Exempt vs. Non-exempt

Workers are often called exempt when they should actually be paid hourly according to federal, state, and (sometimes) local law. Again, it’s hard to keep track of. Either invest in doing worker classification right the first time or be ready to cut a premium check to the IRS. 

9. Thinking This Process is Clear Cut

The government provides guidance, but rules are ever-changing and never 100 percent clear. Asking a few questions and counting the check marks in the 1099 or W2 columns isn’t enough to ensure you classify someone correctly. If you are not an expert, you really need a partner. Engaging someone with specific industry experience who has endured audits is invaluable.

10. Forgetting That Courts Have a History of Siding With The Worker

The system is heavily weighted on behalf of the worker and the burden remains on the employer to do things right.

Yes, it’s important. Yes, it can be a pain. But there’s no need to cut the cord on independent contractors. Keep your worker classification processes at the front of your business priorities or hire a team that can handle your contingent workforce from onboarding through payrolling. 

Interested in learning more about worker classification? You’re in luck, we’ve got a whole series here.

We’ve improved our client experience so to simplify worker classification/compliance, onboarding workers, and obtaining more customized reports. PLUS, we have new updates around the corner.

Here’s How We’ve Been Working to Continually Improve Our Processes

Streamlining Compliance

Independent contractor payroll management can be complicated, but a good partner specializes in simplifying it. With California’s AB5 and the subsequent shockwaves it has sent through the industry, worker classification is on people’s minds for good reason. 

While it’s really hard to standardize some aspects of worker classification, we make the process consistent so clients are using the same rules across the board. Our AI-based software takes much of the subjectivity out of classifying workers by using a consistent set of measurable rules and parameters rather than someone’s opinion.

Another way we continue improving is refining our wording and processes every time we see an opportunity–a big focus for our team! As such, we’ve streamlined communications to reduce email traffic and updated our questionnaires for efficiency. In addition to reducing the turnaround time for onboarding workers, these changes give clients a solid leg to stand on if they ever have to justify their decisions in a court of law. We’ve also made it easier, quicker, and more efficient.

PayReel Online (PRO)/Software Development

Software development may not seem very glamorous until you realize how much time, money, and headache it can save! We’re continually improving operational efficiencies with PayReel Online (PRO) and with our Sick Leave Accrual Management application (SLAM). More states continue to add sick leave and FMLA compliance regulations into law and we’ve enhanced our proprietary tool to manage these rapid changes. No need to worry about the many new complexities these paid sick leave laws leave in their wake. That’s good news for clients who can rest assured we are staying up to speed with the laws. 

In addition to the above software development, we’ve also matrix-ed our system so it can “learn” clients’ system’s language with no human translation necessary. We developed an Application Programming Interface (API) that bridges the gap between client software and ours. This is extra special because it allows PayReel software to communicate with clients’ time-tracking (or any other kind of) software without any human intervention. That means clients can fulfill changing needs quickly without having to rewire/recode (i.e. without disruption). It also allows clients to intuitively connect people to critical information, forms, and reports, and skip maddening double data entry/typing. Sexy, right? 

Take a client with a self-developed proprietary system for time tracking, for example. When we plug their Enterprise Relationship Program into our API, it sends everything needed for a project or a job and updates all 32 necessary fields automatically. That allows us to forego manual data entry with absolutely zero human involvement required in the middle.

Increased Team Training

We really like solid software, but it’s still good people who make the world go around. We’ve instituted a weekly training for all of our Client Relationship Managers (CRMs). In addition to covering any legal changes, this training addresses internal practices to make the client experience as standardized and efficient as possible. 

The Reports Clients Asked For!

It’s true. We saved the best for last. Clients asked for more reports to provide insight into backend payroll information and we listened! CRMs now have the ability to offer many additional customized reports including project cost reports, invoice detail reports, and more–giving supervisors and managers better visibility to see where workers are in the process. 

You already know that W2 employees and independent contractors are entitled to different benefits and typically, independent contractors cost companies a lot less than employees. For this reason, some companies have bent the rules and classified workers incorrectly on purpose. Others have taken advantage of gray areas in the law to save money. And believe it or not, we’ve seen some companies who simply don’t know the rules and misclassify workers unknowingly. No matter the motivation, mistakes are costly.

It’s a New World 

The gig economy, start-up culture, and the rapid growth of the independent workforce have created a trifecta of pain in the form of increased scrutiny by government agencies seeking to ensure workers are appropriately classified. 

In many cases, worker classification laws have resulted in the narrowest definition of an independent contractor to date. It’s now even more crucial for companies to evaluate or reevaluate the way they classify employees and get on the right side of the law before the IRS’s attention reaches their headquarters.

Employee Classification Matters

You can’t ignore worker classification rules. Unless of course, you’re ready to face a potential multimillion-dollar price tag.

You might get away with breaking a traffic law 100 times and lose any fear of the consequences. But that 101st time, you could end up seeing those flashing gum balls in your rear view mirror. Unfortunately, “Oops, I didn’t mean to” holds little weight with police officers. Similarly, the defense doesn’t hold up in court when you’ve misclassified an employee. Whether you knowingly or accidentally misclassify employees as independent contractors, it’s considered wage theft. The government doesn’t take that lightly. 

Committing wage theft has some serious consequences. Businesses that misclassify workers as independent contractors deprive federal and state governments of billions of dollars in tax revenue. Big Brother is watching and Big Brother wants its money.

The cascading effects guarantee continued pain. Misclassifying an employee puts your business at risk of an IRS audit. In addition to monetary fines like back pay, back taxes, severance and healthcare coverage for misclassified workers, you could also be looking at legal fees, reputation damage and even criminal and civil penalties. If you’re found guilty of fraud or intentional misclassification, you may be fined for each misclassified employee with fines multiplying with subsequent violations.  

Conduct Internal Audits

Conduct an internal audit on your company’s policies and documentation process. Run each worker through the ABC test to determine if they really are an IC or not. Look for areas that need improvement. If you’re missing any documentation (like signed contracts), take any necessary steps to get what you need. If you think you’ve misclassified a worker, make sure you carefully document any changes you make. 

If you run your internal audits and still don’t feel confident you have the right status, you can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. To be safe, you should treat the worker in question as an employee until you’re sure.

Not sure if you’re classifying your employees the right way? Take our five-minute worker classification self-audit to determine just how independent your independent contractors are.

Regularly Review Classifications 

Worker roles can evolve over time, as do the rules around worker classifications, so it’s a good idea to review each worker’s classification annually and make adjustments as needed.

That’s a lot of work, which is why many organizations that contract independent contractors partner with an Employer of Record—a firm specializing in independent contractor compliance and engagement. An Employer of Record helps your company meet compliance standards, reduce misclassification risk, and successfully manage independent workers. That’s exactly what we do at PayReel.

Outsource Employee Classification to The Experts

PayReel will help you manage your workers so your business can focus on doing what it does best. As your Employer of Record, PayReel will help ensure that all your independent contractors are properly classified and your business stays ahead of the compliance curve. There’s no need to gamble with something so important. Contact us today! 

Employee classifications identify how the Fair Labor Standards Act (FLSA)  apply to workers and what benefits they are legally entitled to or not. Because of this, the language we use around it matters! The terms we use to define workers can get thrown around interchangeably even though they’re actually different. Let’s define the language around independent contractor, gig worker, and employee.   

Gig worker

Merriam Webster defines the gig economy as “economic activity that involves the use of temporary or freelance workers to perform jobs typically in the service sector.”

The service sector piece is one of the main cues that indicates someone is a gig worker. Ride-sharing drivers and grocery delivery people are good examples. Their “gigs” are on-demand. It usually goes something like this: a customer coordinates a one-time service (such as a grocery cart full of food delivered to their doorstep) through a company like Uber or Instacart. They facilitate the transaction through an app and a worker accepts the task. 

The gig worker, then, is the person who does the driving or shopping/delivering. They might also be an independent contractor, but it’s not the same thing. 

Independent Contractor

Independent contractors are business owners who engage in a contract (either with another business or with an individual) to provide a service. They receive payment specifically for the work they perform and according to agreed-upon terms. Unlike a regular employee, they can pick and choose clients and regularly move from client to client.

Here are some of the key hints that someone is an independent contractor:

• They have a specific skill set and a legally-established business entity
• They report business income to the IRS and pay self-employment taxes 
• They perform work that is not central to their client’s main line of business
• Their work is project-oriented and is typically completed in a specified amount of time

Employees

Okay, so employees are a whole different thing. In short, they’re employed by a company and are entitled to the benefits and regulations that go along with that. There are multiple designations that can apply to employees–part time, full time, exempt, non-exempt. We’ll go into more of that next week.

Still have questions? 

Let us help you. It’s our business to keep clients compliant.

If you’ve come anywhere near a Human Resources newsletter in the last six months, you know the government is serious about targeting misclassification of employees as independent contractors. More attention on worker classification means an already risky business is about to get riskier.

Businesses like to work with contractors because it helps them avoid paying for health insurance, 401Ks, and other benefits. Independent contractors are affordable and available for à la carte services. While some worker advocates make it seem like employees always have the preferential role, many workers prefer the autonomy of contracting. They enjoy the flexibility and the ability to work with a variety of companies and pick their projects. In some cases, it’s truly a win/win. 

On the other hand, when it’s done improperly, it can truly be a lose/lose.

Why do the IRS and DOL care so much about worker misclassification?

Employee misclassification is high on the IRS’s list of least favorite things. You can bet if they have their collective knickers in a bunch, there’s one issue at the core: money. Non-compliance with IRS and DOL regulations governing which workers are classified as W-2 employees versus 1099 contractors means lost tax revenue at the state and federal level. That’s because fewer tax dollars are coming from employers without a corresponding increase in tax revenues from independent contractors.

Businesses are equipped to make sure employees stay in line with labor laws, benefits, worker’s comp, unemployment insurance, and of course, tax withholding. Independent contractors, on the other hand, can operate in the wild, wild west of legal lands. They may or may not pay taxes properly, they may overstate their deductions, and they are just harder to keep tabs on. Incidentally, each of these woes also make the list the IRS’s least favorite things.  

This, combined with huge federal and state budget deficits, is a recipe for stepped up surveillance and enforcement. The IRS, DOL, and several state agencies share employer information with specific the goal of tracking down practitioners of worker misclassification. Worse, the government doesn’t care if employers misclassify accidentally. It’s up to you to abide by the law.

What Are the Risks of Misclassifying Independent Contractors?

There are legitimate independent contractors and businesses who employ them properly, but misclassifying an employee as an independent contractor can be incredibly damaging, costly, and time consuming.

With the government’s increased attention on the subject, news bringing misclassification to workers’ minds, and companies coming under scrutiny, one thing is sure: If you haven’t paid attention to worker classification yet, it’s time.

Relax. We Got It

If you’re concerned about misclassification, we’re here for you. It’s our job to know the laws and keep clients compliant. At PayReel, we make sure our clients are able to hire who they want, when they want and that everyone is classified correctly and paid properly. Contact us anytime at 303-526-4900 or by emailing us here.