The think tank Economic Policy Institute estimates 10 to 20 percent of employers misclassify at least one worker as an independent contractor. It may be an honest mistake, but there is plenty of incentive to use independent contractors. You don't have to pay them overtime or provide unemployment insurance or Workers' Compensation Insurance.
There's more than just financial incentive to hire independent contractors instead of employees. Sometimes, you simply need an expert for a short-term gig, and there's no point in reorganizing your business to make room for a permanent role.
But more and more, employers are blurring the lines between contract work and employee work. The US Department of Labor is cracking down on worker classification, and failure to fall in line could cost your business big time.
The Department of Labor Speaks Up on Worker Misclassification
According to AP News, the Department of Labor's Wage and Hour Division issued some guidance on how to tell the difference between an employee and an independent contractor. The DOL guide [PDF] clarifies how the Fair Labor Standards Act applies to contract work.
The report states some opponents say the guide broadens the definition of a contractor so fewer workers will fit that description. The department's new guidance asserts…
- A worker must be in business for themselves to be an independent contractor.
- A worker is an employee if they are economically dependent on the employer.
- The agreement between the employer and worker isn't relevant to the worker's classification.
Whereas the IRS and many states focus on how much control either party has over the work, this distinction focuses on autonomy. The worker either has it or they don't, which certainly simplifies the classification question.
The report notes the guide could spark more lawsuits over worker classification (and there are already plenty, thanks to the share economy's favorite business model. Example: "Another Day, Another Worker Classification Lawsuit"). That, coupled with the fact the Department of Labor has amplified efforts to cut down on worker misclassification, could mean serious financial woes for noncompliant businesses. AP News states in 2014, the DOL forced companies to pay $79 million in back wages to 109,000 misclassified workers.
For more on the DOL's efforts, read "Labor Department Helping States Crack Down on Worker Misclassification."
The Takeaway: Hire Smart
If the many lawsuits plaguing share-economy trailblazers Uber, Handy, and Lyft tell us anything, it's that the independent contractor business model may not sustainable. California regulators have already decided one particular Uber driver is an employee (more on that in "Uber Ruling: Driver Is Employee, Must Get Workers' Comp"), and that ruling may inform future decisions.
Why is that a big deal? Say a court decides all your independent contractors – most of your workforce – are suddenly employees. You may not have budgeted for the extra costs associated with employees, such as…
- Employment taxes.
- Workers' Comp benefits.
- Overtime pay.
- Health insurance benefits.
Now imagine you had to pay for these costs all at once. You also have to pay back wages and other fines for not classifying your workforce as employees in the first place. (Remember, you can be penalized for not having adequate Workers' Compensation Insurance if your state requires employers to carry it.)
That bill is enough to threaten the survival of billion-dollar startups. What do you think it would do to a cash-strapped small business?
It's worth noting there is no small business insurance policy that can cover legal expenses for worker classification lawsuits. That's why your best form of risk management is to hire smart from the start.
First, read the Department of Labor's guide. If you need someone to provide regular work for your business, it may be smarter to create a role for them at your business. By contrast, if you need help with a specific project, hire an established contractor who has their own insurance and clientele. As always, you should consult a legal adviser or HR specialist for specific guidance.
For more contractor hiring tips, check out our post "The Small-Business Owner's Guide to Contractor Liability Insurance" and "Workers' Comp Insurance: When Is Someone a Contractor?"