OnePoint Blog

Cost of Misclassifying Independent Contractors

  • 01.20.2017

Misclassifying employees at independent contractors
can lead to penalties, fines and lawsuits 

independent contractor checklistWhen making the decision “Is this worker an employee or an independent contractor?” it is important that employers properly classify workers from the beginning of the work relationship.  State and Federal governments are all stepping up their audits and enforcement and misclassification can result in penalties and fines from agencies such as the IRS and the Department of Labor.

Employer Obligations

When classifying a worker as an “employee” you must withhold different taxes (FICA, FUTA, SUI, Social Security, Medicare, etc) and maintain the many obligations as their employer such as wage and hour laws (including minimum wage, meal periods, overtime, exempt employee classification), various other employment laws (such as ADA, ERISA, FMLA, NLRA and applicable state, county and municipal regulations) as well as  health insurance (depending on company size).

Additionally, unemployment claims cost’s affect an employer’s annual assigned state unemployment tax rate and Workers’ compensation premiums are calculated based on an employee’s base wages and are an additional hard cost expense absorbed by the employer.  These are some of the reasons why classifying an individual as an Independent Contractor appears beneficial for businesses.  However, inaccurate misclassification can lead to a multitude of problems, fines, penalties and more!

Be careful, This is on the Federal Government’s Radar!

The DOL is strengthening enforcement of these rules by granting funding to 19 states to enhance auditing programs. Nineteen states have been granted an $8.2 million pot to split and enhance misclassification auditing programs. The DOL, EEOC, and IRS are aggressively auditing employers.

You must ensure that your independent contractor’s employment status legally qualifies as such. Often businesses will see independent contractors file for unemployment after their assignment has ended. If the state finds that the worker was misclassified, the business is subject to the unemployment claims and may face fines.

In the event of misclassification, the IRS can also seek back taxes and other contributions that should have been paid on the employee’s behalf. Workers can also seek compensation for job benefits that were denied due to improper classification. And, the DOL can assess fines and penalties against your business.  One tip is if the individual has a business license, and is not using their Social Security Number in the 1099 agreement, it is more likely they might be properly classified.

Small business Self Help Sites Encourage Litigation!

 A lot of small business websites used as a resource for independent contractors encourage individuals to complete Form SS-8 to ask the IRS to make a determination of their proper classification.  And then, if the IRS determines that the individual is in fact an employee the individual is instructed to contact an attorney to see if they are able to file a lawsuit against the employer under FLSA, state unemployment or workers’ compensation laws, and others.

Other Risks

There are many other ramifications if you misclassify your workers as independent contractors and they are actually employees.

One example is workers’ compensation insurance. If an independent contractor is injured on the job and claims that he or she was misclassified and meets the requirements to be considered an employee, then you or your insurance carrier may be ordered to pay, and you could be fined for failure to provide workers’ compensation coverage as required by law.

Additionally, your workers’ compensation carrier, while conducting their audit, may charge you back premiums for any other  individuals they feel who should’ve been covered under the insurance policy.  One good tip is to have all Independent Contractors carry their own workers compensation insurance and show you proof of such and renewal verification as well.

Play it safe.

If your workers meet IRS guidelines to be legally considered independent contractors, be sure to fully document the relationship, with an attorney drafted 1099 contract, and cross your t’s and dot your i’s.