Freelancers and contractors have been in the news lately. Ride-sharing company Uber filed an appeal in mid-September to a court class action ruling, seeking to quash a certification that could let Uber drivers in California sue the company for expenses, mileage and tip reimbursement, reports Wired.

Thinking about hiring a freelancer? Be sure to clearly define the role first.

Uber has stressed that all its drivers want to work as contractors. Should the court ruling be upheld, the company, which says it facilitates business between the drivers and riders, could be on the hook for millions of dollars and face a change that could undercut its business model.

And this isn't the only example of trouble when companies try to draw a line between contractors and employees. Delivery drivers in a number of states have sued FedEx Ground, claiming they're employees, not contractors. It's not a new problem, either. In 2001, according to "The 401(k) Handbook" on HR, both Microsoft and Time Warner dealt with the legal fallout of treating employees as contractors, with Microsoft paying a $97 million settlement and Time Warner paying $5.5 million. Contractor misclassification has garnered new attention with the so-called sharing economy.

Cost Savings vs. Government Intervention

Treating workers as contractors can save employers significant money by eliminating payroll tax expenses and benefits costs. According to the IRS, savings could run $3,710 per year on a $43,007 salary. That doesn't count additional potential savings in state taxes and workers' compensation insurance.

The U.S. Department of Labor (DoL) addressed misclassification in July. According to labor law firm Seyfarth Shaw, DoL Administrator David Weil wants to "severely restrict the use of independent contractors and to require businesses to reclassify those workers as employees." Government bodies are concerned about worker protection and about missing tax payments, which are easier to secure through payroll deductions than from individual freelancers.

Why Middle Market Companies Should Care

Middle market businesses are precisely at the point between needing to ramp up employment and lacking the expansive resources of a giant corporation; contractors and freelancers help fill the gap. But if companies misclassify these workers, they can find themselves in trouble with the DoL, the IRS and state revenue organizations. They may find themselves liable for penalties, fines and back pay and benefits — and potential lawsuits filed by contractors. Criminal sanctions are another possibility, warns the IRS.

Standards for Determining Contractor vs. Employee

There is no simple rule for determining whether workers are employees or contractors. Various federal and state agencies use different standards. For example, the IRS takes into account "all information that provides evidence of the degree of control and independence" of the employee, using three categories of evidence:

  1. The degree of control the company exerts over what a worker does and how they do it.
  2. Whether the corporate payer controls the job's business aspects, including how the worker is paid, expense reimbursement and supplies.
  3. If there are written contracts or benefits, how long the relationship continues and if the work is a key aspect of the business.

Weil offers a similar six-part test that asks businesses to compare employer and worker investments, determine whether the work requires special skills or initiative, and decide if the worker's managerial skill affects the opportunity for profit or loss. In cases of doubt, agencies err on the side of assuming someone is an employee. This is an area in which hiring competent legal help is important.

When to Use Freelancers

Given the standards' ambiguity, there are no bright-line rules for when to hire contracted help. Midmarket businesses can follow some rules of thumb when hiring freelancers, however. If possible, have the work done on the contractor's premises, using their tools and supplies. Make sure the work isn't directly fundamental to the business, but rather that it's specialized and supportive.

Some companies ask for proof of independent status, such as a business license, evidence of work for other companies, and evidence of work done on the freelancer's own premises and with their own equipment. Another option is to ask workers to sign a contract indicating they are not employed by your company and are free to work for others.

Consider using a contracting or temp agency that treats workers as employees and handles all requisite taxes. It's more expensive, but far less so than dealing with lawyers, penalties and interest.

Does your company hire contractors or freelancers? What tips do you have for clearly defining these roles? Tell us in the comments.

Erik Sherman is an NCMM contributor and author whose work has appeared in such publications as The Wall Street Journal, The New York Times Magazine, Newsweek, the Financial Times, Chief Executive, Inc. and Fortune. He also blogs for CBS MoneyWatch. Sherman has extensive experience in corporate communications consulting and is the author or co-author of 10 books. Follow him on Twitter.