How to Avoid 3 Top Contractor Misclassification Triggers

As we discussed in the last issue, management practices are often the driving cause for freelancers to question the propriety of their IC classification.

And in certain cases we should not blame them for doing so.

If a freelance talent is engaged as an IC but treated like an employee of the company, then that should be seen as a weakness or flaw in the company’s freelance management operations and practice.

That is why at Bupty Compliance Services we monitor freelancer assignment activity on a periodic and event-based basis, to identify trends or potential trigger behaviors of both the manager and the freelancer.  

This segment of our Triggers vs Findings series focuses on screening techniques and key data points that can help mitigate three of the most common triggers driven primarily by contractor behaviors.

3 Common Freelancer Triggers to Misclassification Claims and How to Avoid Them

Unlike the management practices discussed earlier, most freelancer behaviors that expose the client organization to claims of misclassification cannot be fully mitigated.

However, these three common freelancer behaviors occur routinely enough that all organizations should take the recommended precautions to quantify the risk and safeguard themselves from triggers leading to findings of misclassification.

The 3 most common freelancer triggers that cannot be fully mitigated (avoided) are:

1. Economic Dependency

2. Filing for Unemployment Insurance

3. Filing a Workers Compensation Claim

Economic Dependency

What is it? When an independent contractor receives a significant majority of their income from a single client it is likely they are economically dependent on that client.

Or at least that is how the hiring company should consider this factor.

A common threshold for measuring economic dependency is 70% of total freelance income derived from a single client. 

Why this is a trigger:  Dependency on a single source of primary income exposes the freelancer to a significant loss of income if, when the engagement is terminated.

Additionally, there is a correlation between the amount of income from a client and the amount of IC’s time spent servicing that client.

The implied work equivalent of 70% or more of income approaches a full time commitment, which in plain terms limits the IC’s ability to provide work or services to other clients.

Combine these two aspects with an hourly pay rate and a longer term engagement, say 6 months or more, and it is not difficult to understand the dependency that can develop.

On its surface, this set of facts starts to resemble an employer-employee relationship.

(More on this as a finding of fact later in our series.)

And even though it was not designed or intended to be one, it is easy to understand how the IC could begin to “feel” like an employee.

This scenario is more common than you may think and it is a very real trigger risk to a misclassification claim.

When the client terminates the engagement, especially with an early termination, the IC becomes understandably hyper-focused on the pending loss of their primary and majority source of income.

How does the trigger manifest itself?

Sometimes the IC’s reaction is to insinuate they will file an unemployment claim upon termination or to notify the IRS (IRS Form SS-8) of suspected misclassification.

The challenge is that these are often “after-the-fact” behaviors that often the company can not control.

That is why screening for economic dependence before the engagement starts and monitoring for it throughout the engagement is so important. 

How to Avoid Claims Driven By Economic Dependency

Economic dependency is an often overlooked factor when screening freelancers prior to a new engagement.

But there are some screening techniques that can help identify and even quantify the economic dependency for any particular freelancer engagement being considered.

First, let’s recall that IC classification is applied to the freelancer and the entire engagement for which they are being hired.

As is the case for most classification factors, screening of just the freelancer alone will yield an inadequate measure of economic dependency.

So the particulars of the assignment play a material role.

8 Critical Data Points to Protect Against Economic Dependence

Employee classification screening is a mix of art and science, so we often must look at a variety of data points to make factor determinations (i.e. Economic Dependency is a factor we look at when conducting compliance screening).

The following list of data points are what we would typically seek to help us determine if the freelancer has an over concentration of income in a single client.

After each data point below is an indication of the risk associated with their response or the data we find: yellow flag representing moderate concern, red flag representing material concern.

Important to note that no one question or data point is a knockout (i.e. a clear indication of an employer-employee relationship), so the yellow and red flags have to be considered in the context of the entire engagement, all factors.

1. Will the freelancer be paid an hourly rate?  

• Yes to this question is always a red flag that requires an abundance of additional evidence to support an IC relationship.

• No - suggesting a fixed or project-based fee structure - is most supportive of IC.

2. What portion of the freelancer’s total annual compensation will come from this one client? 

• Less than 50% (most supportive of IC)

• Between 50-70% (yellow flag), or 

• Greater than 70% (red flag).  

3. What portion of the freelancer’s time will this assignment consume on a weekly basis? 

• Less than 15 hours (most supportive of IC)

• Less than 25 hours (supportive of IC)

• Between 25-35 hours (yellow flag), or

• 35 hours or more (red flag).

4. How many IC engagements has the contractor entered into over the last 18 months? 

• Zero (red flag)

• 1-4 (yellow flag), or

• 5 or more (most supportive of IC)?

5. How many 1099s (US) did the contractor receive for the most recently completed calendar year? 

• Zero (red flag) 

• 1-3 (yellow flag), or

• 4 or more (most supportive of IC).

6. In addition to this pending client assignment, how many other 1099 engagements / clients is the contractor currently supporting and that have an active status?  

• 0-1 (red flag) 

• 2-3 (yellow flag), or

• 4 or more (most supportive of IC).

7. Is the contractor actively marketing their services to potential clients? 

• No (red flag)

• Yes (most supportive of IC).

8. Within the last 12 months has the contractor been engaged as an employee (company FTE or a W-2 contractor through a staffing firm or employer of record) for this similar kind of work?

• Yes (red flag)

• No (Most supportive of IC)

How to Get The Data

The data points listed above should be ascertained prior to the start of the engagement through any of the below screening methods: 

• Hiring Manager Survey - manager screening survey upon creation or submission of the proposed IC assignment.
  
  

• Freelancer Survey - contractor screening survey prior to parties entering into an agreement or agreeing to the proposed IC assignment.
  
  

• IC Readiness Review - review of the proposed assignment to determine if the work and compensation structure is supportive of an IC classification. 
  
  

• Freelancer Documentation - Asking freelancers to upload documentation to support their independently established business, marketing efforts, business registration, etc. 
  
  

• Independent Research - Especially for determining whether the IC is marketing their services publicly or acknowledging other clients. 
  
  Helpful to ask for links to websites or LinkedIn profiles, etc., but independent verification is recommended as a best practice, as Bubty Compliance Services routinely does.

Where possible, these data should be collected from all available sources and any discrepancies or conflicts investigated and remediated prior to making the classification determination.

At Bubty Compliance Services we refer to this as “conflict resolution,” an instrumental step in our IC compliance screening strategy (which we will dive into deeper later in our series!).

Compliance Monitoring is Necessary

The challenge with IC classification screening prior to IC assignments is that the data collected and used to make the original IC determination is a snapshot taken before the engagement starts.

Circumstances change over time and what may have been accurate before the engagement could become inaccurate during or after the engagement. 

This is particularly troublesome for certain factors in the classification screening that Bubty Compliance Solutions conducts, including Economic Dependence.

To guard against changes, on the client assignment side as well as on the contractor side of the equation, we conduct random and even-driven audits throughout the engagement.

We utilize Bubty platform reporting and alert notification capabilities to monitor IC engagements and identify potentially damaging events so that the Compliance Services team can review and change the classification if necessary.

We also conduct contractor and manager checkins during the engagement to identify any material changes in contractor or assignment status.

The following are events we monitor for on a regular basis that could impact our assessment of Economic Dependence:

• Changing the compensation structure from fixed to hourly.
  
  

• Extending the assignment beyond 12 months in total.
  
  

• Materially changing the original scope of services or deliverables.
  
  

• Contractor ends or loses one or more other clients.
  
  

• Changes in original effort / time required to support assignment.
  
  

• Hiring manager indicates erratic behavior, troubling comments, or performance issues relative to the IC.
  
  

• Change in contractor entity status, submission of new W9, move to new state or country, loss of employment, etc.

Next Issue

In the next issue of The Compliance Capsule we will continue our focus on contractor behaviors that can trigger misclassification inquiries by diving into what happens when an IC files for unemployment insurance benefits.

Can they do that? (Spoiler alert - yes! It is fairly common, especially since the pandemic era.)

And we will explore some strategies to prevent them from doing so and to protect the organization if they do anyway.

Until next Wednesday, stay compliant and be happy.