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Mitigate Your Risk when Using Contractors

Independent Contractor or W-2 Employee?
Avoid Steep Fines by Classifying Workers Correctly

Before you give your new hire his or her first assignment, make sure you’ve given them the right work status first. Existing labor regulations and increasing crackdowns on improper contractor use make it critical to ensure your company is operating within the law.

We’re living in the 1099 generation: Contingent workers will make up more than 40 percent of the workforce by 2020, according to Intuit projections. The shift is happening across the workforce, with many Millennials enjoying the flexibility of contract work and Baby Boomers lending their expertise as consultants to companies facing talent cliffs.

The “try it before you buy it” approach lets companies make sure they’re hiring the right person and gives them the freedom to scale as their needs change. But many companies fall into a trap of treating contractors as employees, which can have serious repercussions. Companies also need to be aware that wage thresholds for exempt employees is just one criteria for the determination of Exempt status.

Don’t risk fines and potential litigation by misclassifying workers. Read on to learn about the latest regulations.

A Changing Landscape

The landmark Microsoft case has been a cautionary tale for many businesses when it comes to worker misclassification. A group of contractors won a $97 million settlement after suing to be included in the company’s qualified stock plan. A court found that the contractors were technically “common-law” employees, making them eligible for the stock plan and other benefits.

To determine whether a worker is a common-law employee, the IRS looks for evidence of degree of control and independence which fall into three categories: Behavioral Control, Financial Control, and Type of Relationship. Among the factors considered by the IRS are who is controlling what the worker does, who is controlling the business aspects of the worker’s job (e.g., expense reimbursement, tools/supplies), and what is the permanency of the relationship. The more behavioral and financial control a company has over the worker, the more likely it is that the person should be taking home a W-2 (and company benefits).

Some companies limit the number of hours freelancers work or the length of their contracts to avoid classifying them as employees. This approach can be inefficient though, and doesn’t actually mean those workers qualify as contractors.

New legislation on which workers qualify as exempt, meaning they don’t receive overtime pay, has created additional complexities for businesses. The Department of Labor’s Final Rules updating overtime regulations roughly doubles the wage threshold for non-exempt employees from $23,660 to $47,476 as of December 1, 2016. This rule was delayed after many companies went ahead and implemented new wage adjustment in anticipation of the rule change.

By The Numbers

The DOL has always had an eye toward FLSA classification as one way to target enforcement. The delay does not change the impact a DOL audit can have on a company. While employers did bump up the pay of employees close to the threshold, many workers would have needed to start recording their start, stop, break and meal times to ensure they were paid for any overtime. For companies used to the occasional after-hours work call or email with these workers, the move would have been an adjustment.

The government is aggressively pursuing companies that misclassify workers, so staying up to date on these changes is essential. Since 2009, the Department of Labor has collected $1.6 billion in back wages for 1.7 million underpaid workers.

Be Confident in Your Classification

Navigating worker classification has unquestionably become more involved. By following a few best practices however, companies can stay on the right side of the law.

For companies that use freelancers, third-party contractors or co-employment arrangements can be the best route. An outside firm provides workers who are W-2 employees of that firm, and the company pays the firm through regular AP /AR processes. Whether you use third-party firms or independent contractors, make sure to:

  • Set boundaries. Sign contracts that spell out the relationship’s scope and timeline. Co- employment is still an issue to watch out for.
  • Let the firm lead. If you use third-party contracting, have the firm control supervisory tasks like assignments, pay rates, time and assignment duration, and provide on-site supervision if you’re using a large number of contractors.
  • Waive benefits in writing. Have contractors sign contracts waiving their rights to participate in benefits and exclude contractors from stock and other benefit plans in the plan documents. 

As your company adjusts to the different regulatory environment exempt/non-exempt rules, review wages and hours for all your salaried employees to see who may be eligible for overtime. Employees who were previously misclassified as exempt may be able to collect back wages, so compensate any affected employees now to avoid a potentially huge bill later. Experienced HR consultants can help determine whether it’s necessary to restructure job positions within your company.

Many companies enjoy the flexibility of choosing how their work gets done, but with that flexibility comes responsibility. Whether you’re paying by the hour or the project, protect your business by doing it the right way.

Get Experience on Demand, Without Risk of Misclassification

Need highly skilled, hands-on support fast? Patina Professionals bring a wealth of knowledge honed from years of experience in leadership positions. Patina minimizes risk by rigorously screening professionals; matching the right executive to the job; handling all payroll, taxes and other financial matters; and proactively managing the engagement from start to finish. Contact us to learn more.


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