How to Avoid Misclassifying Employees as Independent Contractors
After a year of battered margins for many businesses, it’s no surprise we’ve seen an increase in the number of leaders trying to cut down or tame their hiring expenses. Rising IT salaries, which on average climbed 6.9% between 2020 and 2021, have been a primary target.
As a result, some business leaders have asked us about trimming the costs associated with W-2 employees by dealing exclusively with independent contractors. The problem with that? Most companies aren’t ready to navigate the nuanced legal issues related to working with temporary IT consultants on their own. In fact, there’s a risk of misclassifying employees as independent contractors, prompting fines, penalties, and more from state and federal agencies.
What are the consequences of independent contractor misclassification? And how can you unleash the benefits of working with IT contractors without opening Pandora’s box in the process? Here’s some observations every organization should review before moving forward with the plan to work with independent IT contractors.
Big Companies. Big Mistakes. Big Consequences
If the concept of employment misclassification is on your radar, it’s likely a result of the milestone Microsoft case. The tech giant was in the practice of using permatemp workers, keeping them full-time for open-ended periods and mislabeling them as “temporary,” “freelancers,” or “independent contractors” without covering payroll tax and withholding tax. During an IRS audit, a notable number of the so-called “contingent workers” were deemed common law employees.
Why? The IRS concluded Microsoft violated several of the 20 factors used to determine whether an employer-employee relationship existed between the Washington-based company and their “independent contractors.” Some of the key violations the agency felt relegated these contingent workers to employee status included:
- A requirement to work on-site
- Distribution of admittance key cards, office equipment, and supplies
- Designated core work hours
- Supervisors shared with “regular employees”
- Full integration with the regular workforce
When Microsoft conceded to the IRS’s ruling, they completed W-2s for independent contractors for the audited timeframe and paid the employer’s portion of FICA for the preceding two years. What they ignored was compensating for missed contributions to the Savings Plus Plan or the Employee Stock Purchase Plan (ESPP) for that same period. When Microsoft decided to transition a portion of their contingent workers onto the payroll and terminate others, who they funneled to temporary staffing agencies, several former freelancers decided to take the whole conundrum to court.
Eventually known as the Viscaino v. Microsoft case, the whole story of the class action lawsuit is a tangled web of dismissals, renewals, reduction in payouts, and reversal of a lower court’s abuse of discretion, and precedent settings. Eventually, the 8,558 plaintiffs received a $97 million settlement.
Though Microsoft was far from alone with this practice, the high-profile court case made them the poster child for employee misclassification. In the immediate aftermath, organizations were on high alert for any infringements, causing some to shy away from independent IT contractors for a time to avoid unintended employee misclassification and steep penalties. Eventually, the stigma died down and IT consulting blossomed as a viable opportunity once again.
However, if history doesn’t repeat itself, it certainly revisits common refrains. The entire gig economy may now come under fire in the wake of an $8.4 million payout resulting from a lawsuit filed against Uber Technologies. The reasoning? Misclassifying employees as independent contractors. There’s a chance this can ripple through the market again, as well as strengthen California Assembly Bill 5 in a way that muddies the water for working with independent IT contractors nationwide.
How to Avoid Misclassifying Workers
If reading all that made you skittish, it’s important to note that working with the right type of IT contractors can be made into a relatively safe and cost-effective process. Yes, the U.S. government wants their pound of flesh, but corporations and legal professionals have dissected this case from a variety of angles to determine how to protect their interests and customers from fines, penalties, and other legal recourse.
If you’re looking to use low-risk IT contractors, make sure you follow these recommendations to maximize your budget while steering clear of legal quicksand.
1.) Assess Status Early & Often – Since this is well-worn legal territory now, there are plenty of resources that can help organizations to identify any red flags for employee misclassification. The 20 factors from the IRS as well as a three-factor ABC test can reveal instances where contractors fall into an employee-employer agreement. These types of evaluations should happen when offers are extended and candidates are onboarded as well as over the course of longer-term contracts.
Realistically, any time the scope, duties, or timeline of a project changes, your organization should reevaluate the contractor relationships to avoid employee misclassification. Providing government agencies with an audit trail can simplify the investigation process and diminish the risk to your organization.
2.) Avoid 1099s – Few arrangements are riskier than working with 1099 independent contractors on your own. Often, many of these professionals only see an opportunity to have flexibility and control over their hours and work without comprehending their obligation to pay estimated taxes or self-employment taxes at all. As a result, their naivete gets everyone else up the chain in trouble.
When the IRS realizes that tax obligations have been overlooked, they’ll often go after the bigger fish, the companies working with 1099s, determining they’re more likely to pay the fine and resolve the back taxes. Unless you’re running 1099 contractors through a staffing firm that is well-versed in these evolving employment classification issues, then you are only exposing yourself to needless liability.
3.) Partner with an Attorney – Legislation, legal statutes, and precedents are evolving and changing all the time. Attorneys that specialize in labor laws will remain abreast of the nuances of the law while also being upfront in situations where an employee or contract violates those laws.
On the flip side, they will always err on the side of caution, taking a conservative and defensive stance to mitigate the risk of noncompliance. In some cases, their guarded advice can prevent you from pursuing an arrangement that is safe and statutory-compliant. At least, it can be if you partner with the right guide.
4.) Trusting a Staffing Partner – If you want to work with an IT contractor in any way other than as a direct W2 employee of your firm, it’s better to go through an experienced IT staffing services partner. They take on the risk of using a contingent workforce to handle projects or temporary needs.
At iSphere, we take the time to educate our clients on situations where their requests fall outside legal employment classifications. We want to help you avoid fines and penalties, so we’re not afraid to speak up. By taking the legal burden off our clients, we optimize their hiring spend without putting their business in the crosshairs.
You don’t have to worry about misclassifying employees as independent contractors with iSphere. We can guide you through the process of working with low-risk IT contractors, unlocking cost-effective placements without costly legal consequences.