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The U.S. Department of Labor (DOL) is cracking down on misclassifying workers as independent contractors (ICs). But the problem is, classifying workers isn’t easy. The standards can be so confusing, some call it a “crazy quilt” of laws.

In response, the DOL created a “Misclassification Mythbusters” web page in hope of clearing some of the confusion. Not only does this show how much gray area surrounds worker classification, it also shows how vulnerable companies are to misclassification risk.

Mounting Pressure for Companies

In spite of the rampant confusion, companies must get classification right. The DOL showed it’s not letting up anytime soon when the agency asked the IRS and each of the 50 states to work with it in preventing employees from being misclassified as independent contractors. So far, 35 states have signed on to the DOL’s “Misclassification Initiative.” In fiscal year 2015 alone, the DOL says, these collaborations resulted in more than $74 million in collected back wages.

What does this mean to you?

Employers should expect misclassification issues to include both state and federal agencies. This means greater audit risk and more costly and time-consuming investigations.

What to Watch Out For

If you haven’t done so already, you should carefully review all your workers engaged as independent contractors to verify they’re correctly classified. Remember that ICs are independent business owners. From that lens, consider these key points made by the DOL for U.S. workers:

  • Being an IC for one law does not necessarily make them an IC for other purposes (e.g., unemployment or workers’ comp).
  • Receiving a 1099 or signing an IC agreement does not necessarily make them an IC.
  • Having an EIN and an LLC or other business entity does not necessarily make them an IC.
  • Working from home or from another location away from the client’s worksite does not necessarily make them an IC.
  • Being a bona fide IC in the past does not necessarily make them an IC now. It’s a best practice to classify a worker at the start of each project.

How Companies Can Minimize Risk

One way to reduce misclassification risk is by conducting a time-consuming and expensive internal audit. Then re-structuring, re-documenting and re-implementing each independent contractor relationship in a manner that’s compliant with federal and state governing laws.

An easier way to reduce liability is by using third-party classification services. This can be done by engaging costly legal and tax experts, or by using a Freelancer Management System (FMS). Some providers, such as Upwork Enterprise, support all types of contingent workers, including both ICs and staffing agency employees.

End-to-end solutions like these are becoming the preferred choice, as clients can source, engage, pay, and check project statuses all from a single dashboard. Not only does the automation cut down your administration time, you can also avoid costly agency markups for the same talent—which can save you up to 30 percent.

Misclassification claims are rarely covered by insurance, so a single claim could severely damage a business. That’s why in many cases, a company’s legal or procurement department requires that it use a classification service. These valuable services can reduce your risk of audits, administrative claims, and lawsuits.

Is a Classification Service Right for You?

According to the latest Freelancing in America survey, 55 million Americans freelanced in 2016. And this trend is growing so quickly, it’s predicted that freelancers will make up half of the U.S. workforce by 2020.

Based on these numbers, if you’re not dealing with worker classification now, you’ll likely be doing so soon. Because more of your much-needed talent will prefer freelancing over a traditional job.

This is why smart companies aren’t looking at classification services just for risk mitigation. Smart companies are looking at classification services as a strategic way to build infrastructure for the future workforce.Table format checklist of questions to determine whether a company should consider hiring a classification service or not

4 Questions to Ask When Choosing a Classification Service

When considering a classification service, increase your protection further by asking these critical questions:

  1. Do you have legal counsel and other experts supporting your classification services? Some solutions may only apply general guidelines without the benefit of in-house experts. This can be concerning because every engagement is different, and it’s not always possible to apply complicated balancing tests correctly without legal counsel. Make sure the service doesn’t take a “once and done” approach. For maximum protection, its compliance team should classify each worker for every project.
  1. Is each classification in compliance with federal, state and local employment and tax regulations? If you’re in California but engaging a worker in New York, you want to make sure that worker is in compliance with New York’s state and local regulations as well as federal laws. Worker classification involves various balancing tests to determine whether workers are operating independently without direction or control. Your service should use more than one—if not all—of these tests:

• IRS 20-Factor Test

• Economic Realities Test

• ABC Test

• Restatement (2d) of Agency

• Common Law “Right to Control” Test

• Other Applicable Statutory and Common Law Tests

  1. Do you provide indemnification? Even if it’s the service’s fault a worker was misclassified, it is not required to pay the cost of possible future loss, such as tax and wage liabilities. Make sure your service provides indemnification.
  1. What areas do you serve? Some classification services classify workers only within a certain region. If you have wide-ranging needs, consider a service that covers all areas you might hire from, so you’re not limited to the talent you can engage. For example, Upwork Enterprise can complete compliant engagements in more than 180 countries—and can do it within two to five days.

Focusing Your Compliance Efforts

As workforce trends show, it’s almost impossible to get work done without engaging freelancers. And the penalties and tax liabilities for misclassifying workers are high. If you haven’t done so already, prepare your workforce infrastructure now by having enough classification experts in-house. Or by handing this complicated task to a reputable classification service. It’ll free you from worry, so that you can focus on the work.