How to Avoid Employee Misclassification

5 Ways to Avoid Employee Misclassification

In today’s employment landscape, there is a growing redefinition of independent contractor rights in the U.S. Independent contractor abuses have led many independent workers and freelancers to file lawsuits against employers, leading to a heightened awareness of worker misclassification issues.

If your small business hires independent contractors, temporary workers, remote workers, or freelancers, it is important to understand that they cannot be engaged or treated like traditional W-2 employees. Doing so risks an audit, leading to many negative consequences including large fines, bad press, back tax payment, stalled acquisitions, and class-action lawsuits.

Below, we look at five ways your small business can avoid employee misclassification, which ultimately leads to an audit and subsequent penalties.

1. Create an Accountability Support Team

A cross-functional team keeping an eye out for potential misclassification violations can save you a big headache down the road. If possible, include representatives from four main areas.

  • Job sourcing
  • Human resources
  • Compliance
  • Legal

The team – which can consist of both in-house and outsourced members – should be on the lookout for audit triggers such as independent workers filing for worker’s compensation, disability, or unemployment claims and ensuring that contractor hiring and management processes stay compliant and up-to-date.

2. Make Work Contracts Mandatory

Using a written contract for all independent contractor engagements helps define your working relationship clearly and helps to verify classification in the event of an audit.

In addition to outlining the scope of work, defining the communication process, and specifying payment terms, you may want to consider including additional safeguards such as explicitly stating that the person you’re engaging with is an independent worker and free from control and that they have insurance.

3. Properly Classify All Independent Workers

The federal government, state government, and government agencies all apply different laws and tests to determine worker classification. These tests lack uniformity, so just because a worker complies with one test, doesn’t mean they’ll comply with another.

While this complicates the vetting process, it is still important to be aware of these laws when assessing the classification status of workers. In general, it is good practice to keep records of documents that support a classification decision such as a business or professional license, business cards, or insurance certificates that can be used as proof of self-employment.

4. Create and Enforce a Worker Classification Policy

Your business may have a worker classification policy in place, but do employees consistently follow it? If not, you could be at risk. Work with your HR team or hiring managers to develop a centralized program for engaging and managing your independent workers.

Program policies should be understood and enforced across the board, and have the flexibility to evolve as needed. Consider possible barriers to implementing a program, and develop strategies to overcome obstacles for a smoother adoption process.

1. Review and Update Classification Practices Annually

Conducting an internal audit is a valuable practice that can provide you with an in-depth understanding of your current classification practices and whether or not they are compliant. Your internal audit will consist of three main steps:

  1. Gather records of services performed by contractors.
  2. Check to see if you have contracts on file for your independent engagements.
  3. Confirm if the contractors you’ve engaged in the past have federal tax ID numbers.

Are you able to prove that all of the contractors you’ve engaged qualify as independent workers? Investigating your practices can help identify gaps and areas for improvement before a regulatory agency steps in with an audit of its own.

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