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Classifying Employees as Contractors: You May Not Even Know You’re in Violation…

It’s no secret that the United States Department of Labor (DOL) is cracking down on the misclassification of workers in businesses around the country.  Organizations are being slapped with hefty fines for incorrectly classifying some of their employees as independent contractors, also known as self-employed or 1099s, and many find themselves responsible for paying back taxes and penalties.

Correctly classifying workers ensures that both employers and employees abide by Internal Revenue Service (IRS) requirements, avoid fines, and receive the rights and protections to which they are entitled.  Below, Roth Staffing Companies delves into the difference between employees and independent contractors* according to the IRS, as well as the penalties for misclassifying employees as independent contractors.  In addition, we provide best practices for employers struggling to determine whether their workers are independent contractors or employees.

 

The Difference Between Employees and Independent Contractors

When assessing whether a worker is an employee or contractor, the IRS independently assesses three factors under the purview of common law, resulting in a comprehensive assessment.

Behavior

A worker is considered an employee in this category when the employer possesses the power to control the worker and determine the way that he or she fulfills the job.  For instance, the employer may demonstrate their ability to direct a worker’s performance by providing training that details how to complete job responsibilities

Finances

The financial relationship between an organization and its workers might also indicate whether the workers classify as contractors.  If an employer controls the economic aspects of the position such as providing the worker a regular wage and paying for the tools and equipment necessary for the job, it may be required to designate the worker as an employee.

Nature of Relationship

How the worker and business perceive their relationship impacts the worker’s designation as an independent contractor or employee.  For instance, if the workplace provides health insurance and benefits such as a pension plan and paid vacation, this implies an employer-employee relationship.

 

Fees, Fines, and Penalties for Misclassification

Since 2011, the DOL and the IRS have jointly focused on employee misclassification, punishing even high-profile organizations like Microsoft for failing to provide proper taxes, pay, and benefits to certain employees.  If your department or organization incorrectly classifies its workforce, you are at risk of accruing the following severe penalties and fees, as outlined by the IRS.

  1. If the organization filed a Form 1099 and unintentionally misclassified an employee as an independent contractor, then the employer is liable for:
    1. Federal income tax withholding: Up to 1.5% of the employee’s income
    2. FICA taxes: At least 20% of the employee’s share plus the employer’s share
    3. Unemployment taxes: These are based upon the percentage of taxes that should have been withheld
    4. Additional interest and penalties assessed by the IRS based upon the amount of the employer’s liability
  2. If the organization didn’t file a Form 1099, its liabilities include:
    1. Federal income tax withholding: Up to 3% of the employee’s income
    2. FICA taxes: At least 40% of the employee’s share plus the employer’s share
    3. Unemployment taxes: These are based upon the percentage of taxes that should have been withheld
    4. Additional interest and penalties assessed by the IRS based upon the amount of the employer’s liability
  3. If the organization purposefully and knowingly misclassifies an employee, it could be responsible for paying:
    1. Federal income tax withholding: Up to the entire amount that should have been withheld
    2. FICA taxes: Up to the full amount of both the employer and employee shares (an employer may pay less if the employee pays part of the self-employment tax)
    3. Potentially significant interest and penalties assessed by the IRS
    4. Possible criminal and civil penalties

“The IRS standards are not the only ones that employers need to analyze.  State agencies apply varying and different standards, and employers also need to be aware of how courts in their jurisdictions interpret the definition of an employee.  Thus, even if an employer meets the federal standards of proper classification, a state agency may deem that individual should have been classified as an employee based on the state’s dissimilar standards.” says Jennifer Simonson, Senior Vice President and General Counsel for Roth Staffing Companies.  “Remember that classifying a worker as an independent consultant should be a rare exception rather than the rule.  Government agencies have an interest in auditing employers because misclassification results in revenue for those agencies.  When in doubt or if there is a grey area, take the conservative approach.”

 

Common Classification Mistakes Seen by Roth Staffing Companies

As an expert in contingent labor, Roth Staffing works with a lot of clients who utilize temporary labor as part of their staffing and business strategies, and is also charged with keeping up on misclassification trends and tips.

The following critical classification mistakes are common among the business public, and should be avoided in order to comply with classification laws.

  1. Assuming that a worker is an independent contractor because he or she signed a contract, or asked to be treated as a contractor
  2. Treating the worker as a contractor because he or she receives intermittent assignments
  3. Labeling workers contractors because they are paid commission only or fulfill assignments for multiple organizations

 

Avoiding Penalties

There are several courses of action available for organizations and departments unsure about whether to treat a worker as an employee or contractor.  For example, the company or worker can file a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS.  Receiving an official determination may take more than six months but workplaces with several of the same type of ambiguous worker might find this option worthwhile in the long run.

Also, businesses can partner with a firm that specializes in correctly classifying workers.  “Some workplaces find it easiest to reach out to a 1099 compliance management firm when exploring whether their workers are independent organizations or employees,” explains Dave Savarise, Senior Vice President of About Talent, one of Roth Staffing’s specialized business lines.  “Organizations or departments considering this option should do their research to conclude that the classification firm is reputable and qualified to differentiate between employees and 1099s.  Workplaces apprehensive about accidentally misclassifying workers also have the option of partnering with a staffing or payroll firm.”

 

*We use the term “worker” to differentiate from “employee,” which refers to an employer-employee relationship, and an independent contractor (or contractor), who is not considered an employee.

 

Sources: United States Department of Labor, United States Internal Revenue Service, Paychex