If cellar door is the most beautiful phrase in the English language, then employment compliance might be the most frightening one. It shouldn’t be.
When hiring and employing contract employees, keeping yourself—and your business—on the right track, especially regarding employment compliance is important.
Compliance violations run the gamut from innocent mistakes to brazen fraudulence. Whether a compliance violation is due to a simple and innocent oversight or repeated unethical behaviors, the ramifications can be huge.
In this article, we’ll explore the five biggest employment compliance mistakes businesses make, the damage they can create, and how to avoid them.
Which came first, the W2 contract employee or the 1099?
We’re starting with misclassification because it’s a recurring problem in compliance. Many of the mistakes we’ll explore in this article can (and often do!) snowball into misclassification issues, too.
Misclassification occurs when employers incorrectly designate workers as independent contractors instead of employees. This is a serious violation of labor laws both in the U.S. and globally.
While contractors and employees can perform similar tasks, their legal status significantly impacts tax obligations, labor protections, and benefits.
Worker classification mistakes can lead to severe penalties, including fines, back wages, and personal liability for business leaders.
Regulatory agencies, such as the IRS or the Department of Labor (DOL), treat misclassification as a serious compliance violation. Guess why?
Not only does misclassification deprive workers of rightful protections, but it also denies the government their due taxes. The saying “death and taxes” exists for a reason.
TL;DR: The IRS really, really doesn’t like it when employers misclassify to save money.
Misclassification often results from misunderstandings. The legal definitions of contractors and employees can seem tricky.
For example, employers may wrongly assume that labeling someone a "contractor" in a contract or agreeing to pay them without withholding taxes automatically makes them a contractor. They would be wrong.
In reality, classification depends on specific legal criteria, such as the degree of control the employer exerts over the worker’s schedule, tools, and work processes.
Misclassification is a huge employment issue because many employers do it intentionally— often as a cost-saving measure.
Employers may deliberately categorize workers as contractors to avoid paying payroll taxes, benefits, or overtime. While this may seem like a quick way to cut costs, it is a high-risk strategy that can result in costly legal battles and reputational damage if discovered.
In a landmark case from 2021, Holland Acquisition Inc., operating as Holland Services, was ordered to pay $43.2 million in damages and back wages to hundreds of workers who had been misclassified as contractors.
The U.S. Department of Labor found that these workers were performing tasks under employer control, a key factor in determining employee status. This case highlights how misclassification can lead to massive financial repercussions and underscores the importance of compliance with labor laws.
To avoid misclassification errors, businesses should:
By addressing misclassification proactively, businesses can minimize risks, avoid costly legal disputes, and build trust with their workforce.
When building or growing a contract workforce, adherence to local, federal, and global laws is paramount.
Sounds easy enough, right? Sort of.
Depending on where a business—and its contractor—are located, contractor classification, tax obligations, and labor protections can vary. Failure to understand and adhere to these laws can result in misclassification, tax audits, penalties, and lawsuits, creating significant disruptions to business operations.
Since employment laws can change several times a year, this creates a bit of a moving target when it comes to compliance with laws.
Failing to comply with employment laws can jeopardize a business’s financial stability, legal standing, and overall reputation.
Following every law is a hassle, man!
While we jest, it’s kind of the vibe here. Whether or not intentionally. An employer might look to take a shortcut or two. When onboarding employees, operating a business, and paying taxes, it behooves a business owner to know all labor and employment laws.
Failing to comply with local labor laws can also lead to reputation damage and strained relationships with contractors.
For example, if a business ignores laws related to payment timelines, workplace safety, or non-discrimination policies, contractors may feel exploited and take legal action or share negative feedback publicly. This not only tarnishes the company’s reputation but also makes it harder to attract and retain skilled contractors in the future.
In summary, ignoring local laws creates a cascade of risks, including financial penalties, legal disputes, and reputation harm.
Businesses can avoid these pitfalls by staying informed about regional regulations, standardizing compliance procedures, and seeking legal counsel when expanding into new markets. Doing so not only protects the organization but also fosters trust and accountability in contractor relationships.
Know your laws. It can be overwhelming and legalese around local laws can do a good job of obfuscating the core message.
However, the fate of an entire business could be in jeopardy by breaking (or failing to realize) a local employment law.
Use high-level labor laws (like the Fair Labor Standards Act) as a north star to create a common sense foundation when it comes to labor laws.
Don’t stop there. Take steps to familiarize yourself with any local laws
For example, state laws in states like California, New York, and Washington are known to offer protections for employers. In the United States. Washington, D.C. often ranks #1 when it comes to labor protections.
If your business operates or employs folks from states known for workers’ rights, it’s imperative that you know and follow these laws.
Lawyers are expensive. But proactively hiring a lawyer to review local laws will be much more cost-effective than fighting a tax oopsie.
Simply put, documentation is important. It establishes the tone of the employer-contractor relationship from day zero.
Contracts, Statements of Work (SOW), and tax forms establish the terms of the contractor relationship and ensure compliance with labor and tax regulations.
Without program management and detailed documentation, a business might operate in a gray area. This increases the likelihood of disputes, misclassification issues, and regulatory penalties.
Since we work with many innovative technology companies, let’s quickly address intellectual property! Failing to secure intellectual property agreements can leave a business without full ownership of critical deliverables, potentially leading to costly legal battles or loss of valuable assets.
Contractors unbound by written agreements may mishandle sensitive data or fail to adhere to compliance standards, exposing the business to regulatory fines and reputational damage.
In times of rapid growth, it can be difficult to keep track of onboarding processes.
Another growing pain that can lead to non-compliance happens when companies exceed a threshold of employees. For example, a business with over 50 employees can be subject to a slew of local and federal laws that smaller companies avoid.
To avoid these pitfalls, businesses should implement standardized documentation processes.
When building these processes, ensure that contracts are comprehensive and legally sound on a case-by-case basis. Regularly review agreements against current and upcoming regulations.
This proactive approach safeguards the business while fostering transparent and professional contractor relationships. It’s a win-win for everybody involved.
When onboarding is inconsistent, key compliance steps might be overlooked. This exposes a business to legal and financial liabilities.
On an operational level, inconsistent onboarding can also result in unclear expectations and incomplete documentation. This lack of clarity can lead to disputes over deliverables, payment terms, or work ownership.
Sloppy onboarding, like a failure to properly train contractors on company-specific compliance requirements, can expose the business to risks of data breaches or non-compliance with industry regulations.
When it comes to onboarding, our biggest advice comes from the 1942 romantic drama, Casablanca—in the form of a quote.
“This is the beginning of a beautiful friendship.”
Bogart-ify your onboarding process, because it establishes the foundation of the contractor relationship. Why not make it beautiful?
Consistent and thoughtful onboarding safeguards your company against some of the sneakier compliance issues. It also has the added benefit of bolstering the entire company’s reputation.
By standardizing onboarding procedures, businesses minimize compliance risks, streamline operations, and establish a more reliable and professional contractor relationship. Nobody wants to be known as "that company", the one contractors hate working with.
When hiring contract workers, there should always be an established means to monitor hours and/or a Statement of Work (SOW). The statement of work should outline specific deliverables and timelines.
When businesses fail to track a contractor’s progress in relation to the agreed-upon parameters, the lines between their status as a contractor and employee become blurred. This is the perfect storm for a misclassification risk.
If a contractor’s hours and tasks resemble those of an employee, it could lead to reclassification by regulatory bodies. This can include regular schedules, strict oversight, or added tasks outside the original SOW.
Along with reclassification come hefty penalties, back taxes, and mandatory provision of employee benefits.
In these cases, a business could owe unpaid payroll taxes, insurance contributions, and even damages to the contractor for benefits they were denied.
Operationally, poor monitoring can also lead to project delays and budget overruns. Without tracking contractor hours and deliverables, businesses may end up paying for unproductive time or work that deviates from the SOW.
This lack of accountability undermines project efficiency and creates unnecessary financial strain.
If contractors take action on suspected misclassification, it can lead to disputes, contract breaches, and damage to professional relationships.
Implementing proper oversight systems protects a business legally and ensures that contractors deliver value as expected—on a pre-established timeline.
Now that you’ve learned about some of the biggest (and costliest) compliance misdeeds, don’t fret.
To protect your business from the risks of skipping proper documentation, misclassification, or failing to comply with local laws when hiring contractors, implement a standardized contractor onboarding process.
This process should include:
Detailed Contracts and SOWs: Create legally binding agreements that clearly outline the contractor’s classification, responsibilities, payment terms, deliverables, and intellectual property rights. Tailor these documents to comply with the laws in the contractor’s location.
Compliance Checklists: Develop a compliance checklist to ensure all necessary documentation, such as tax forms (e.g., W-9 or W-8BEN), confidentiality agreements, and proof of contractor classification criteria, is completed before work begins.
Legal and HR Expertise: Work with professionals to stay updated on local labor laws and regulations. HireArt can help you create templates and processes that align with legal requirements, reducing the risk of missteps.
