Shareholder and employment law attorney Haley Harrigan offered her perspective on the pitfalls of relying on contract labels over actual control for "Independent Contractors vs. Employees: 5 Legal and HR Perspectives – Part 1," authored by Brett Farmiloe, contributor for HR.com. Haley's comments underscore the importance of evaluating the true nature of a working relationship to ensure compliance and avoid misclassification risks.
Independent Contractors Vs. Employees: 5 Legal And HR Perspectives – Part 1
Understanding the evolving definitions of employment in a multi-state and global workforce
The classification of workers as independent contractors (ICs) versus employees is one of the most significant legal and operational challenges facing businesses today. Misclassification is costly, exposing employers to tax penalties, back-pay liabilities, and class-action claims.
In this two-part series, we present ten legal and HR voices who examine the risks, compliance challenges, and the changing definition of work in the gig economy.
This first part focuses on core compliance pitfalls that every employer needs to understand.
- Navigating Multiple Classification Tests and Legal Leverage
- The Pitfalls of Relying on Contract Labels Over Actual Control
- California Risks, Proactive Compliance, and the Loss of Employee Benefits
- Identifying Signals of Misclassification and Mitigating Financial Exposure
- Key Tax Compliance Requirements and Upcoming 1099 Reporting Changes
Navigating Multiple Classification Tests and Legal Leverage
The most common pitfall employers encounter is the misconception that control is the important factor governing classification, followed closely by the misconception that a totality of the circumstances test or IRS test will universally apply. In reality, there are multiple different IC tests depending on the jurisdiction and circumstances. For instance, a worker can be correctly classified for tax purposes but still misclassified under wage and hour purposes. Businesses should also not assume they are "safe" simply by classifying gig workers as employees. While this fixes the misclassification problem, IC classification is often essential to the nature of gig work. Since gig workers are often mobile, their work can easily involve multi-state employment law compliance.
Furthermore, their desire for flexibility means compliance with time sheet laws, lunch break laws, and I-9 requirements presents unique challenges. A company is not mitigating risk by classifying a worker as an employee unless they can also follow the applicable employment laws associated with the work.
The only real way to ensure proper classification is to learn the local laws that apply. However, two tricks can help mitigate risk: first, contract only with entities, not people, fostering business-to-business relationships, as this makes classification as a 1099 less likely to be challenged in many jurisdictions. Second, have all workers sign individual, binding mandatory arbitration agreements, which demand significantly fewer resources than addressing a class claim. Misclassification of any worker potentially gives the misclassified worker power to negotiate a settlement or severance that is more valuable than the actual lost benefits they are claiming, similar to blackmail.
Companies often pay the employee more money than they could ever collect to get a release, to avoid the worker filing a claim, going to state agencies, or trying to assemble a class. Worker classification will remain state-by-state because the rules are embedded in local laws, and states traditionally impose greater work restrictions than federal law.
Alicia J. Samolis, Partner, Partridge Snow & Hahn
The Pitfalls of Relying on Contract Labels Over Actual Control
Too often, businesses rely on a worker’s title, a contract label, or the fact that they are paid by a 1099, rather than the actual nature of the relationship. Simply calling a worker an “independent contractor” in a contract or compensating a worker with a 1099 does not necessarily make them a contractor. Regardless of what’s stated in the contract, if the employer actually controls how the work is performed—including setting hours, schedules, and providing equipment—the worker is likely an employee. A common pitfall is companies allowing their workers the “choice” of being compensated by a 1099 instead of a W-2; although this may sound like flexibility, it is usually a red flag that suggests misclassification.
To ensure proper classification, businesses should use written agreements that reflect the actual working relationship and conduct periodic audits throughout the working relationship. Businesses should also train HR and managers on proper distinctions and are encouraged to consult with legal counsel. Misclassification affects workers by depriving them of wages and other protections they would have been legally entitled to as employees, including unpaid minimum wages (and potential overtime), employer-sponsored benefits, unemployment and workers’ compensation insurance, and various workplace rights.
Haley Harrigan, Employment & Litigation Attorney, Gallagher & Kennedy, P.A.
California Risks, Proactive Compliance, and the Loss of Employee Benefits
Companies face multiple risks when misclassifying workers as contractors instead of employees, particularly in California. These risks include individual lawsuits or DLSE claims for unpaid overtime, failure to pay minimum wage, missed meal and rest breaks, penalties, and attorneys’ fees. Companies also face the risk of PAGA lawsuits or class action claims. Additionally, companies could be audited by state and federal agencies, including EDD, FTB, DOL, and IRS.
The first practical step is to contact an attorney, as every state has different laws regarding contractor classification. Even when classifying a worker as an IC, a company can minimize financial risks by evaluating and complying with the underlying wage and hour laws; for example, many companies ensure they are paying minimum wage plus overtime for all hours worked. Ensuring the company is working with an independently established company (sole prop, LLC, or corporation) rather than an individual helps prove a legal IC relationship in some states.
When misclassified, ICs lose out on employee benefits and protections such as overtime compensation, mandated meal and rest breaks, health insurance or retirement, and qualifying for unemployment if terminated. IC classification has been, and will continue to be, state by state because each state has a different political and economic climate, and in California, workers’ rights are a priority embedded in public policy.
Leiann Laiks, Partner, Strategy Law, LLP
Identifying Signals of Misclassification and Mitigating Financial Exposure
The biggest pitfalls involve misunderstanding or ignoring the strict tests used by federal and state agencies to properly classify contractors versus employees. Some businesses intentionally misclassify workers to avoid paying employer payroll taxes, offering benefits, and abiding by overtime rules. Standards must be evaluated against the IRS's common-law test, the US Dept of Labor's economic realities test, and state-specific criteria, such as California's ABC test.
A contractor is signaled as misclassified when: 1) The worker is controlled like an employee (i.e., hours, methods, and tools) but paid as a contractor; 2) The work is integral to the company's core business; or 3) The contractor has little to no independence (e.g., ONLY supporting one client full-time). Misclassification can lead to massive back-pay liabilities, tax penalties, and benefit claims, which can be extremely costly. Steps businesses can take include: conducting a legal audit; reviewing the role against federal and state criteria; documenting the contractor's autonomy in the contract; avoiding "employee-like" control (set goals, but let the contractor determine resources); periodically reassessing the relationship; and training managers.
Misclassified contractors miss out on overtime, minimum wage protections, and employer contributions to Social Security and Medicare. They could also face unexpected tax burdens, as contractors are required to pay both employer and employee portions of Social Security and Medicare taxes, meaning 15.3% annually of gross earnings. Given the sharp political divide and patchwork of state laws, the state-by-state approach is expected to continue in the near term, although pressure for a unified federal framework is mounting due to remote work blurring boundaries.
Kim Mack, SHRM-CP, PHR, Founder/principal, HR Reinforced
Key Tax Compliance Requirements and Upcoming 1099 Reporting Changes
Worker classification—misclassifying an IC as a W-2 employee or vice versa—is a common yet very expensive mistake. If a contractor is truly independent, they shouldn’t be using company equipment, working specific hours, or reporting to a manager like an employee would. Key tax compliance requirements include the collection of W-9 forms before any payments are made. Additionally, if a company pays $600 or more in a calendar year, they must issue a 1099-NEC to the contractor and file it with the IRS by January 31st. These are often overlooked because internal systems weren’t built to handle the volume.
Recent changes are creating confusion. The "One Big Beautiful Bill Act," signed July 4, 2025, revoked the planned $600 threshold for Form 1099-K reporting. It reinstated the original threshold of $20,000 in gross payments and 200 transactions per year for 1099-K reporting by platforms like PayPal and Venmo for the 2025 tax year and beyond. Separately, the reporting threshold for Form 1099-NEC and Form 1099-MISC will increase from $600 to $2,000 for the 2026 tax year. HR systems need clear systems to track income and issue forms correctly due to these backdated changes.
The most common mistake gig workers make is assuming they don’t need to report income if they don’t receive a form (like a 1099-K), an assumption that results in penalties, as the 1099-K is a reporting tool, not a determination of what is taxable. Gig workers should treat every dollar as reportable. The second major mistake is not paying quarterly estimated taxes. Since taxes are not automatically withheld, gig workers must calculate and pay their own income and self-employment tax throughout the year, often ending up with unmanageable tax bills and underpayment penalties. They should make estimated tax payments if they expect to owe at least $1,000 in taxes for the year, using the IRS Form 1040-ES and submitting payments on April 15th, June 15th, September 15th, and January 15th of the following year.
Anush Gasparian, Director of Human Resources, Phonexa
Click here to read the article published by HR.com.
About our attorney
Haley Harrigan represents and counsels individuals, small businesses, franchised operations, and large companies on a wide range of employment issues, ranging from internal compliance to wage-and-hour litigation. She serves as chair of the firm’s employment and labor law department.