Creating an Effective Contingent Labor Program: Getting Classification Right 

Following on my introduction to this series, this first installment focuses on the critical importance of correctly classifying the members of your independent workforce.  

In the past, the onus was on independent contractors to make sure they were set up correctly and paying the right taxes – the IRS would audit them directly. That has changed and it’s now the company’s responsibility to not only make sure the independent is paying their taxes but also that they qualify as a contractor to begin with.  

To get an expert view on classification in today’s workplace, I talked to Heather Prindle, MBO Senior Director of Strategic Business Controls and Compliance. Heather is a subject matter expert when it comes to compliance and classification of independent contractors.  

Q: How does an enterprise go about classifying independent professionals?

There are multiple tests to help discern an employee from a contractor. The IRS, Department of Labor, State Agencies, and Workers Comp tests are some examples. It’s good to keep in mind that the focus is on protecting the enterprise from risk.  

Q: At what point does a company need to start considering the classification of its independent workforce?

Right away, as soon as the company starts hiring independent professionals. Keep in mind that it only takes one person to create issues. The attention from government agencies doesn’t arise from an audit. It shows up, for example, when someone makes a worker’s comp claim, or someone applies for unemployment. Then red flags start going up: This person was paid as a contractor, so why do they think they’re eligible for unemployment?  Agencies can talk to each other now, so if you get one audit, you’re likely going to get several audits from different agencies. Predictably, this can open a big can of worms if you’ve done it wrong.  

Q: How does independent contractor classification differ between industries and states?

There are always different factors that could be considered across different industries. A good example is people working on reality TV shows asserting that they should have been employees but were paid as contractors.  A former “Love is Blind” contestant filed a lawsuit against Netflix for these exact reasons. There are examples in other industries, and it’s a new area that companies are still trying to navigate. So it’s important to understand the factors in your industry and be smart about who you’re qualifying as a contractor. 

It’s also important to understand the requirements of the state (or states) in which you do business. In California, for example, the AB5 rule basically says if a person is performing work that’s core to your business, they’re not eligible to be considered a contractor. For example, if you operate an accounting firm and you’re hiring an independent as an accountant, that’s not allowed. As an accounting firm, you need to have accountants on payroll.  

Q: What type of documentation does a company need to get from their independent contractors?

At a minimum, a W9 form; this allows you to pay the person. Collect proof that they are out marketing their services to other clients; this is a big thing that government agencies look for in their tests. Collect documentation of other clients—contractors can show proof of other revenue streams which show they’re not dependent on that business for revenue. You should also make sure they can verify insurance to make sure they’re protected. 

Q: What is a common classification issue you’ve seen when an enterprise sets up its independent workforce?

Hiring contractors can’t be a siloed decision within departments. This can leave the company open to risk including back taxes, penalties, and fines from audits. To be successful, establishment of a process for hiring independents needs to be supported at the top. You want to make sure that everyone on the senior leadership team is aware of, on board with, and understands what to expect. I’ve seen many cases where a department manager will complain because they just want to work with someone as quickly as possible. They need to have the support and guidelines from upper management to say that the hiring process might be a bit involved and cause some delay at first, but it’s to protect the enterprise in the long run. 

Q: Is there anything else you’d like to cover on this topic?

Yes. Classification is not a one-time thing. Conditions change. Make sure you have an annual re-evaluation to make sure that the members of your independent workforce are still in compliance with their contractual requirements, their companies are still in good standing, that state laws haven’t changed, and any other factors that require attention.