3 Common Reasons for Independent Contractor Misclassification

Independent Contractor Misclassification

Independent contractor misclassification is a complex topic, so it’s no wonder that so many businesses struggle to check all the boxes when they’re onboarding freelance talent. While sometimes misclassification happens on purpose, a lot of the time it’s just a misunderstanding or a knowledge gap on behalf of the company. However, ignorance is not an excuse in the eyes of the government. Whether you were purposely misclassifying workers or you really had no idea of the rules, the penalties will stack up just the same. 

If you want to learn about how you can automate freelancer classification to remove the risk of misclassification, book a demo of the Fiverr Enterprise solution!

To learn more about the topic, this article looks at why independent contractor misclassification occurs, what the legal implications could be, and how your business can prevent contractor misclassification in the first place. 

This article is part of our guide on Employee Classification.

Why Does Misclassification Happen?

There are three main reasons why independent contractor misclassification happens. 

  1. Intentional misclassification: It can save a business as much as 30% to hire a freelancer instead of a full-time employee. This is because businesses don’t have to withhold the same taxes from an independent contractor, and also don’t need to offer benefits such as pension contributions, health insurance, and sick pay. As a result, some companies use freelancing as a workaround to reduce their labor costs.
  2. Lack of knowledge: For many companies, there’s nothing sinister in their misclassification of freelancers. They genuinely believe that they are hiring a freelancer, but the working relationship is actually employee/employer. This can happen when someone calls themselves freelance but doesn’t work for any other business but yours, or perhaps because you wield too much control over how much they are paid, where they work, or their processes.  
  3. Evolving nature of the freelance workforce: The freelance revolution has got governments sitting up and paying attention, and often adjusting compliance and regulations to meet the new landscape. This means that compliance with misclassification rules can often be a moving target. Even if a freelancer is compliant when you onboard them, things can change, and some businesses don’t have a process to maintain compliance moving forward. 

The Legal Implications of Misclassification

If a company has been found to have misclassified any of its workers, there can be steep legal and financial penalties. Your business could be liable to pay up to 3% of the misclassified employees wages, all of the FICA taxes that weren’t paid for the employee, and as much as 40% of the FICA taxes that were not withheld from the employees wages. These are also known as back taxes. On top of this, the IRS can ask you for $50 for every single W-2 form that was not filed correctly and on time. 

These are just the IRS penalties. Especially if you have been found to misclassify employees as freelancers intentionally, you may come up against class-action lawsuits, criminal penalties of as much as $1,000 per worker, and even prison time. There are wage claim audits that include unpaid overtime claims and minimum wage deficits, and employers could also be asked to repay any benefits that should have been attributed to the worker. This includes pension contributions, health insurance costs, and payment for sick leave, parental leave, or vacation days. 

How to Prevent Contractor Misclassification

Workforce classification is the responsibility of the business, not the freelancers or the government, so it’s important to have a plan in place to make sure that all workers have the right designation and status. This should be a plan that covers existing workers as well as new hires, as the goal posts regularly change on misclassification rules. 

First, make sure you regularly review and update worker contracts and job descriptions to cover the work that they complete, and the way they work. For example, check in with freelancers whether their status has changed in their opinion, or whether they’ve moved from self-employed freelancer to opening their own LLC. 

Review with your managers how they are utilizing freelance talent, and make sure they know the common law rules, and how they might risk compliance, for example telling freelancers specific hours that they need to be available, or enforcing their use of your own processes, technologies, and systems. HR should also be well versed in misclassification laws in your region, so that any grievances or issues can be shared early and fixed with ease. 

You can consider implementing regular auditing processes to check out potential misclassifications, but this can certainly add a lot of manual work, and is never totally foolproof. 

Sidestepping Contractor Misclassification with Fiverr Enterprise

Fiverr Enterprise is a SaaS solution that gives you full visibility and control over your entire freelance workforce by allowing you to source, hire, onboard, manage and pay, all while ensuring compliance, so your teams can work faster and maximize business growth. 

When it comes to misclassification, you can’t afford to take a risk on manual effort. The truth is, only an automated system can ensure that your freelance workers are always compliant in a continuous way, without adding a huge amount of manual work and administrative overhead. And your procurement, HR and managing teams have better things to do, and too much other strategic work to be searching through each freelancer’s paperwork individually to make a judgment call on compliance. 

Fiverr Enterprise takes out the subjectivity. We automate and customize all the legal and tax compliance processes necessary for your industry and location, and take care of tax forms, background checks, misclassification vetting and more. 

As the process is continuous, it goes a lot further than just onboarding freelancers compliantly – you can sidestep manual audits and know that all freelancers are always classified correctly and fully compliant, unless alerted otherwise. From onboarding to offboarding, you have the peace of mind that every step of the freelance lifecycle is totally in order. 

As we automatically monitor all relationships with your freelancers, if risk arises, for example in the way your freelancer is working, or the validity of their legal forms, you get an immediate alert. We’ll include steps for mitigation, so that you can quickly and confidently take action. 

This makes you 100% audit-ready 100% of the time. 

Schedule a 30-min call with one of our workforce experts to hear more about how we can scale your freelance workforce.