Worker Misclassification Audit

Managerial Control

Central question in any investigation is the degree of oversight that the company exercises over the daily activities of the person performing the work. A worker misclassification audit examines whether the firm dictates the specific hours of service, the location of the work and the methods used to complete the tasks. If the company provides the tools and the training and has the power to discipline the individual, the relationship is likely to be viewed as employment.

True contractors are expected to have their own equipment and the freedom to work for multiple clients and the ability to set their own schedule. The auditors will review internal emails and manuals and project management logs to see how the work was actually managed on a day to day basis. This functional test focuses on the reality of the situation rather than the labels used in the written contract.

Management teams must be careful not to treat their freelancers like subordinates if they wish to avoid a reclassification.

Financial Exposure

Findings of an investigation can lead to a massive bill for unpaid taxes and benefits going back several years. When a worker misclassification audit results in a change of status, the company is usually required to pay the employer share of social security and unemployment insurance for every affected individual. These amounts are often increased by interest and heavy penalties for the failure to report the income correctly.

The workers themselves may also gain the right to claim back pay for overtime and holiday pay and other statutory benefits they missed while they were classified as contractors. In some cases, the total liability can threaten the financial viability of a small or medium sized business. This risk is particularly high for startups that have used a large number of gig workers to scale their operations quickly.

Investors perform their own versions of these audits during due diligence to ensure they are not buying a company with a hidden tax debt. Proper documentation of the contractor relationship is the only defense against these significant financial risks.

Remediation Process

Correcting the status of the workforce requires a systematic approach to update the contracts and the internal processes of the firm. After a worker misclassification audit identifies a problem, the company must decide whether to bring the individuals onto the payroll as full time employees or to change the way it interacts with its vendors. Bringing people on as staff increases the fixed costs of the business but provides greater control and legal certainty for the future.

If the company chooses to keep the contractor model, it must ensure that the relationship is truly independent and that the workers have the right to hire their own assistants and work for others. This may involve redesigning the project management system to reduce the level of direct supervision. The company should also implement a formal policy for the hiring of contractors that includes a checklist of the criteria used to determine their status.

This proactive stance shows the authorities that the company is committed to following the law and helps to prevent future audits. The accurate classification of the workforce is a requirement for the long term stability of the corporate structure.