Think you know how to define accurate employee classification examples compared to situations where workers are wrongly classified as independent contractors? It might be more complicated than you think.
According to the IRS, businesses need to weigh up many considerations when classifying their employees as either a freelancer or an employee, putting specific facets of the relationship under the microscope, as well as looking at both the financial and the behavioral status of the worker. If you get it wrong, and treat employees as freelancers, you could end up with misclassification penalties as well as a demand that you pay back all the missed employment taxes for those workers.
Here are 3 employee classification examples gone wrong – situations where what looks like a freelancer, is actually an employee in disguise. We’ll choose one from each of the IRS’ three categories of common law rules, Behavioral, Financial, and Type of Relationship.
This article is part of our guide on Employee Classification.
Behavioral challenge: Specific on-the-job training
Alex is a Gig worker, picking up different roles, depending on what comes his way. He considers himself to be self-employed, and an independent contractor. Alex answers a job advert for a freelance virtual assistant, to cover a worker who is heading on parental leave. He will need to cover various tasks such as managing incoming emails, setting appointments, and liaising with other members of the business. Alex can do all of this in the hours that work for him, as long as the work gets done. However, the company would like to make sure that Alex can fill the shoes of the current employee, so asks him to come in for some training. Alex will shadow the existing virtual assistant, and learn about what the job entails, how to use the right software and hardware in the office, and get a feel for how the company likes the job done.
What’s the problem? Independent contractors usually work with their own methods. The IRS comments, “If the business provides the worker with training on how to do the job, this indicates that the business wants the job done in a particular way. This is strong evidence that the worker is an employee.”
Is Alex an employee? It’s possible! The more training that the company expects, and especially if it is periodic or on-going, the more likely that Alex is an employee.
Financial challenge: A monthly fee or set salary
Jamie is an accountant, and has been working freelance for some time. They have many ongoing clients who send various ad-hoc tasks, as well as certain jobs which always come in at the same time of year, according to tax season. One business in particular has been ramping up their financial accounting and compliance standards, and is sending Jamie more work than ever before. The business asks Jamie if they would consider some kind of retainer. In fact, they comment – why don’t we pay you a set $3,000 a month, and you can be available for all of our ad-hoc needs? You could even come into the office 2 days a week! Jamie loves that idea, with the stability of what feels like a monthly income. But is it too close for comfort in the eyes of the IRS?
What’s the problem? Independent contractors are usually paid for defined, specific tasks, or in professional services – for hourly work at a set fee. The IRS outlines, “[If] an employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time, this usually indicates that a worker is an employee.” Coming into the office for a set amount of time each week would make the situation even dicier, as independent contractors usually control where they work and during which hours they complete their tasks.
Is Jamie an employee? If the company doesn’t list specific jobs which are Jamie’s responsibility, and assign those each with a monetary value, and if Jamie chooses specific days and times to be in the office, then even if Jamie has other clients – they may well be considered an employee.
Relationship challenge: Activities that are key to the business
Amelia is a developer who is hired as a freelancer by an exciting new start-up. The tech company has a fantastic idea for a new mobile app, and they need someone to code the application. Amelia has tons of experience and is perfect for the job. She has other clients too, regularly taking on ad-hoc short-term projects, and she sets her own hours and the location in which she works. The local Cafe Nero plays the best music, in her opinion. The company asks her what the price would be to build the app, and she gives a competitive rate, to which they readily agree. The company feels confident that Amelia is considered a freelancer, as she is in control of her own behavior, including when and how she works, and how much money she makes. They are excited about their great talent find, as the app is the very center of their business, and will decide whether it succeeds or fails.
What’s the problem? The nature of Amelia’s work might mean that the IRS considers her to be an employee, as the work she is doing is core to the service or product of the company. As a result, the business will want to have a lot of control over how she works and the outcome of what she builds. As the IRS comments, “If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities.”
Is Amelia an employee? This one is not clear cut. In general, the more key to the business the work outsourced to an independent contractor is, the more likely that the IRS will consider them to be a misclassified employee. In this situation, it would be more important than ever to ensure that you have a freelancer contract that codifies that you do not have an employee-employer relationship, including defining the scope of the agreement, IP arrangements, and more.