Triggers vs Findings - Understanding How Misclassification Claims Arise - Part 2

How an Organization’s Management Practices Can Put Them in Compliance Peril

In Part 1 of our series we looked at how the IRS and state tax authorities review conflicting tax filings to identify potential claims of employee misclassification.

Here in Part 2 we continue our review of how an organization’s own management practices can place them in compliance peril.

The good news is that risky management practices can be fixed.

Freelance Management Practices 

When companies manage independent contractors as employees it can be confusing to them and it can instill a belief that they actually should be an employee and not an independent contractor.

Based on the criteria that the IRS and other state and federal agencies establish for proper employee classification, there are both explicit and implied management behaviors that are appropriate for management of employees but not appropriate for management of independent contractors.

I will go into greater detail on the dos and don’ts of IC management behaviors in a later issue, but for our purposes here, I will provide a few examples to demonstrate that how you manage an IC engagement can in and of itself be a trigger to a misclassification inquiry or claim. 

Direction & Control and Form SS-8

Imagine an independent contractor being supervised in a similar manner to how the employees are supervised.

Or imagine the IC being required to attend a staff meeting along with mostly other employees.

Think about an independent contractor who is required to work from 9-5, sit in a cubicle next to employees, and has been provided a desktop computer to use that is identical to the one employees are using. 

Finally, think about an independent contractor with a work email address assigned to them, just like the employees use.

I have layered on several examples of criteria that most governing agencies have identified as evidence of an employer-employee relationship, and NOT evidence of an independent contractor relationship.

Again, I will dive deep into how direction and control is actually the most pervasive client-based finding later in this series.

But for now, just think how that “independent contractor” may feel or how they may perceive their role in the client organization.

It doesn’t take all those scenarios of them being treated like an employee - in fact, sometimes it just takes one - for them to start to feel like an employee or to start questioning why they aren’t an employee.

Many inquiries and claims of misclassification start off as a worker engaged as an independent contractor but managed as an employee.

Why is this considered a trigger?

Because once a worker starts to think of themselves as an employee it is not difficult to understand how they then start to believe that they should have been hired as an employee in the first place; That they too should have access to employer-funded health insurance; that they too should be invited to the company holiday party; that they too should receive stock options to reward them for they work they have done.

And probably not a surprise to anyone, the IRS has a form for just this occasion.

IRS Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Department of the Treasury Income Tax Withholding is a form that workers can file independently to effectively ask the IRS to intervene and help them get reclassified as an employee.

Doing so would then give the reclassified worker access to the benefits and other employee treatments that they likely expect in this example. 

There are other independent contractor determination criteria - beyond direction and control, how the client company supervises the worker - that can also lead to misclassification inquiries by workers themselves.

For instance, if an IC is paid an amount for their services that equates to something close to or even below minimum wage, then that worker is a trigger risk (and likely understandably so!).

By way of example, from an article by Tittle & Permuter: “In 2018, the Economic Policy Institute found the median wage for Uber drivers after expenses and fees was $9.21 an hour.

That’s well below the rate considered a “living wage” in places like Los Angeles and New York City.”

The low net pay rideshare drivers were receiving was a key driver of their pursuit to be reclassified by rideshare companies as employees. 

How to Safeguard Against Client Triggers of Misclassification

Triggers to agency inquiries about potential misclassification - whether driven by red flags identified by the agencies themselves or by workers thinking they should be reclassified and taking their own action - are often easily avoidable.

Relative to our examples above, consider the following:

• Develop a 1099 hiring policy that does not permit 1099 contractors who have been a company W-2 employee within the last 12 months.

  
  

• Document freelance management practices (and provide training) that

  • Minimizes supervisory control over ICs

  • Requires ICs to provide their own equipment

  • Disallows ICs from attending general staff meetings and employee events

    
    

• Develop freelance contracting standards or policies that 

  • Eliminate hourly rates for ICs that are below a certain level (i.e. 200% of minimum wage)

  • Remove hourly rates altogether from IC contracts, instead compensating ICs with fixed fees based on results

  • Prevent engagement of 1099 workers for certain types of work (i.e. blue collar roles or roles that company employees current fill)

    
    

• Establish 1099 screening and onboarding processes that ensure workers engaged as 1099 

  • Have a history of providing the underlying services to other clients

  • Acknowledge they are being engaged as ICs

  • Acknowledge that they are not entitled to the benefits employees are entitled to

  • Act like a business (i.e. market themselves, have multiple clients, provide their own equipment, don’t require supervision to deliver their services, etc.).

Next Issue

In the next issue of The Compliance Capsule we will take a closer look at contractor triggers of misclassification and how to mitigate risks that are based almost solely on the contractor’s behaviors.

This will be an important distinction from trigger risks that are in the company’s control to avoid, as we have discussed here in this issue. 

Until next Wednesday, stay compliant and be happy.