The 1099 independent contractor model can be the ideal setup for some employers and workers. However, the misclassification of workers — a risk that is significantly increased when housing independent contractors in an HRIS — can be costly.
The complexity of navigating an independent contractor workforce deepened following the Dynamex Operations v. Superior Court decision out of California in 2018.
By understanding how to interact with independent contractors, how to train employees on their interactions with independent contractors, and what systems to use to document the difference between W2 employees and 1099 contractors, you can take the necessary steps to mitigate the risk of an audit and class-action lawsuit.
Misclassification of Independent Contractors
A number of issues can lead to an audit revealing a misclassification of an employee as an independent contractor.
Often, problems arise when an independent contractor is injured while working. Under such circumstances, a lawyer might reach out to them and point out that since they don’t have insurance, they should file for workers’ compensation even though they are classified as an independent contractor.
Of course, workers’ compensation is just one of a number of sparks that can lead to an audit. Others include unemployment claims, IRS SS-8 inquires, wage-hour claims, or state human rights violations. Additionally, various agencies beyond the IRS might take a particular interest in your company. These include unions, the National Labor Relations Board, the Equal Employment Opportunity Commission, or the Department of Labor.
Any red flag might cause these agencies to take a more in-depth look at your interactions with independent contractors, especially if you’re keeping independent contractors in an HRIS.
The Consequences of Misclassifying Workers
Employee misclassification has been spreading like wildfire in the headlines. Uber, caught up in a misclassification lawsuit, settled for $170 million following a vast majority of their more than 60,000 drivers filing arbitration claims. Similarly, GateHouse Media paid up to $425,000 to settle a misclassification lawsuit with regards to newspaper carriers.
The costs of settling misclassification lawsuits seem to have recently ranged from $3,400 to $40,000 per independent contractor employed. However, those costs are only the tip of the iceberg with regards to the consequences of misclassification.
There can be significant tax consequences if the IRS is involved in the audit. Additionally, if the IRS believes that the misclassification was intentional, there could be criminal charges — which carry penalties of up to one year in jail and a $1,000 fine per worker up to $500,000.
Other state and federal regulators have their own set of penalties, which can quickly cripple a company. None of that is even factoring in the costs of legal fees in fighting or settling any accusation of misclassification.
The Dynamex Operations v. Supreme Court Decision
Dynamex Operations v. Superior Court decision out of California in 2018 is one of the primary reasons companies working with independent contractors are scrambling to ensure they’re not opening themselves up to any unnecessary legal risk.
Dynamex Operations, a nation-wide courier company, moved to reclassify its drivers as independent contractors, which lead to a class-action lawsuit from the drivers on various grounds.
From this decision, the court decided to move away from a multifactor way of determining employee classification to the burden of proof being put on the company via an “ABC test”.
Under the ABC test, the burden is on the company to prove that a worker is an independent contractor.
Additionally, given California’s role as a trendsetter for labor laws in the United States, there is speculation that the stricter ABC test could become commonplace throughout the nation.
So… What is the ABC Test?
The ABC test focuses on three specific factors and puts the burden of proof on the hiring agency. To pass the test, the hiring agency must be able to answer yes to three questions.
- Does the person do work independently of your control and direction?
- Does the work they perform fall “outside the usual course” of your company’s business?
- Do they have their own independent business or trade beyond the job for which they were hired?
Not all jurisdictions are using the ABC test at this point. The key is to find a local employment lawyer to help you understand the laws in your state and industry.
Training Staff to Work with Independent Contractors
Specific language used in the workplace is one of a number of factors that can impact the misclassification of independent contractors. This can get particularly tricky when you have frontline managers working with both W2 employees and independent contractors.
Creating a culture within your company that treats and sees independent contractors as independent business owners and operators is essential. When interacting with them, it is helpful to ask the question: How would I interact with another company that is providing this service for me?
It is essential to work with key players at every level of the company so they understand the independent contractor model, how to talk with independent contractors, what can be asked of independent contractors, and how an independent contractor is different from an employee.
Though terminology isn’t everything, it is super important: if it looks and smells like an employee term, don’t use it with independent contractors.
In the same way that the wording used when interacting with independent contractors is necessary, the terminology used in designing contracts for independent contractors is essential.
Using ICIS Technology to Solve the Misclassification Problem
For the same reason that nearly all companies now use HRIS technology for managing their human resources, having a similar system set up for independent contractors is important.
This is particularly true because every interaction with an independent contractor increases the risk of a misclassification audit. However, this can be heavily mitigated through a robust system, best practices, and precise documentation of the interactions.
That doesn’t mean you should implement the system you already have in place for keeping track of employee information. In fact, having independent contractors in HRIS is a huge red flag when it comes to the misclassification of workers.
Instead of having independent contractors in an HRIS, it is possible to be more insulated from legal liability if you use a third-party system, such as an independent contractor information system (ICIS) or a professional independent contractor organization (PICO).
By not having independent contractors in HRIS, but rather an ICIS or PICO, a third-party can track all the interactions between your business and the contractor’s business from contract negations to archiving settled contracts.
Understand Dangers of Housing Independent Contractors in HRIS
When it comes down to it, housing independent contractors in an HRIS adds risk, while everything about an ICIS mitigates risk when using an independent contractor model.
An ICIS is just another tool you need in your toolbox to help you stay on the right side of the law and ensure that an independent contractor is treated like a vendor and not an employee.