If a staffing agency pays workers assigned to its clients as independent contractors and not as employees, the agency faces potential liability for misclassifying its workers. Similarly, if the independent contractor candidate is paid directly by the client, the client assumes these risks. So unless your agency or your client has a high risk tolerance, you should ensure that the individual meets the test for independent contractor status prior to agreeing to treat them as an IC.

So, what to do if you find the perfect candidate for a client, but the candidate wants to be paid as an independent contractor? How do you proceed?

What’s the Test?

Determining whether an individual can be appropriately classified as an independent contractor involves analyzing and weighing numerous factors related to both the nature of the work and the background of the independent contractor candidate. For example, does the company provide workspace on-site, company email or voicemail or equipment? Will the pay be hourly or based on a deliverable schedule? Is the IC candidate incorporated as an independent business? Evidence of other clients? These are just some of the questions a staffing firm must raise when evaluating whether a candidate should be classified as a contractor or employee.

It’s Not Just the IRS

The IRS and the Department of Labor recently announced a $46 million effort to coordinate both agencies’ enforcement aimed at businesses that misclassify employees as independent contractors.

And if the government doesn’t get you, those workers classified as independent contractors might. The most common type of legal challenge to an employee’s classification status involves unemployment benefits. Workers may also make claims for workers’ compensation, unpaid overtime, or other benefits provided to employees such as profit sharing or stock options. If your company has multiple independent contractors that are similarly situated, the potential exists for class-action lawsuits, which could be very costly.

California Penalties

While many states have laws targeting misclassification on an industry-specific basis (for example, the construction industry), California law casts a wider net — applying to any company that misclassifies workers. Effective Jan. 1, companies that “willfully” misclassify workers as independent contractors are subject to a fine of $5,000 to $15,000 per violation. If there is found to be a “pattern and practice” of such violations, the fine increases to $10,000 to $25,000 per violation. Furthermore, companies who are found to have violated the law must post a notice of the violation on their website for one year.

And watch out — the law also imposes joint liability on third party agencies (such as staffing firms) that knowingly advise an employer to treat an individual as an independent contractor to avoid employee status for that individual.

Reducing the Risk

The best protection from misclassification claims is to have a consistent process for screening and approving independent contractors. The determination should not be made solely by the staffing manager or hiring manager. The evaluation should consider both the scope of work and level of supervision as well as the qualifications of the independent contractor candidate as an independent business entity. Document the terms of the independent contractor relationship in an agreement that defines the scope of work, project duration and payment schedule and also provides that the independent contractor is required to make all required tax and other withholding payments and is not entitled to benefits provided to employees. Be sure to maintain appropriate documentation — create files by company name with copies of the documents you have reviewed and considered. Set up the files for review and reevaluation as appropriate.

Careful attention to independent contractor classification practices can help protect you and your client from unwanted potential liability. Act now to make sure you are not placing your business at risk.