Mitigating the Compliance Risk of Misclassifying Contract Workers

Don Tennant
Slide Show

Tech Employment Picture Bright for Start of 2014

As employers continue to rely more heavily on freelancers to lower their labor costs, an issue that’s likely to get a lot more attention is the misclassification of contract workers. Basically, the problem is that employers often have contractors working alongside full-time employees, doing the same work under the same conditions. The government doesn’t allow that, because it relies so heavily on payroll taxes, and contract workers aren’t on the payroll. So if they’re indistinguishable from full-time employees, the government wants them classified as full-time employees.

The misclassification issue came to the fore in 2000, when Microsoft, after years of legal wrangling, paid a $97 million settlement stemming from an IRS audit of its worker classification history. Since then, the IRS has gotten even more aggressive in conducting audits of companies to ensure they’re in compliance with worker classification laws.

I recently spoke about all of this with Jeffrey Wald, co-founder and COO of Work Market, a provider of cloud-based contract labor management services in New York. Work Market’s clients use its platform to hire freelance workers, and rely on Work Market to help mitigate compliance risks. That includes compliance with respect to worker classification laws, and Wald acknowledged it’s an area that can be tricky:


We can build software that allows a legal department, or an HR department, to start to set up what it means to be in compliance for them. It’s not for us to say what’s right and what’s wrong, because the laws are so opaque. But if ABC Corp. tries to send too much work to [independent contractor] Joe Smith in an inappropriate way, our algorithms will start to adjust and adapt. We think about it in three ways. First, we look at Joe Smith as an independent contractor: How is he structured, legally? Has he set up a separate corporation? Does he have a number of additional customers, a website, a logo? That’s Question number one. Question number two relates to ABC Corp. What does ABC Corp. do, and are they going to have Joe Smith perform the same functions that a segment of their own employees does? Our data structuring can look at that. Question number three is how Joe Smith and ABC Corp. interact. Specifically, what direction and guidance is ABC Corp. giving? Is Joe Smith going to an ABC Corp. location, or to a customer location? Are they reimbursing his expenses? Are they paying him hourly? Do they give him tools and specific guidance?

Wald explained that it all boils down to three basic parameters that the IRS considers—operational, behavioral, and financial—and who has control over those parameters:

Operationally, are you coming to my location, and am I giving you tools? Behaviorally, am I telling you what to do, or am I just telling you what needs to be done, and you are doing it? Financially, who is paying you, and do you have a risk of profit or loss? The IRS has 19 different provisions, broken down within these three broad categories. I can take all that data, I can put it into my algorithms, and I can offer a mitigant to you, where if you engage Joe Smith too frequently in the wrong way, we’re going to decrease his relevancy to you in search. Those are things that help mitigate that risk. But it’s important to note that these are mitigants. Everything that we do from a software standpoint—and we have customers like SAP and Omnicom, very large corporations that have dug deep into our flows to make sure that our software can do what we say it can do—regardless of what it is that we’ve built, and how much we can code the system and build algorithms, the government’s the government.

Wald went on to explain that what makes all of this so difficult, for employers and contractors alike, is the complex, overlapping web of regulatory frameworks that they have to deal with. And he said something has to change:

Different states have different unemployment boards, worker’s comp boards, and their own departments of labor. You have, obviously, the IRS, the federal Department of Labor. And I don’t think anybody really has a firm idea as to what it is to be compliant, jurisdiction by jurisdiction, state by state, and then throughout the country. And obviously, our customers are working globally. So this is an area where I think there has to be some regulatory evolution, because the way people work is changing. And because payroll taxes are such an important part of government revenue, the government is going to have to come up with a new way, a new structure, of taxing labor to make sure that it’s providing the revenue that the government needs, but recognizes the reality in the changing labor landscape.



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Feb 28, 2014 12:47 PM Richard Reibstein Richard Reibstein  says:
This is a very thoughtful blog post that identifies the conundrum faced by businesses using independent contractors. Algorithms may serve as mitigants, but the only tried and true means of enhancing independent contractor compliance is by restructuring, re-documenting and re-implementing the independent contractor relationship in a comprehensive manner, consistent with business objectives and a myriad of federal and state laws. Indeed, state laws are changing every year in a number of states. It is oftentimes best to try to meet the standards of the more restrictive state laws, if at all possible, maximizing compliance in those states that use the common law approach endorsed by the U.S. Supreme Court. This can be done using IC Diagnostics™ and other proprietary tools and processes (http://independentcontractorcompliance.com/legal-resources/ic-diagnostics/). Reply

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