Do you know the penalties for improperly classifying employees as Independent Contractors?

by Michael Haberman on December 14, 2015 · 1 comment


Worker misclassification may result in government agencies coming down on you hard.

Worker misclassification may result in government agencies coming down on you hard.

I gave a presentation the other day, on behalf of ComplyRight,  on how companies can incorrectly classify workers as independent contractors rather than employees. Many companies think that using independent contractors is a prudent way of doing business. It reduces an employer’s liabilities, keeps costs down and provides greater flexibility than might be achieved by hiring an employee. It is indeed a great option AS LONG AS YOU DO IT CORRECTLY. Improperly classifying workers as independent contractors can lead to a long and expensive list of penalties.

What are these mistakes?

There are a good number of mistakes that are made, or things that are missed, by improper classification. These include:

  • You have not paid an “employee” correctly. You may have missed overtime.
  • You have not recorded work time correctly.
  • You have not filed the appropriate federal and state tax forms.
  • You may not have made appropriate contributions to retirement plans.
  • You may not have complied with the ADA.
  • You may not have provided them with the appropriate protections under either OSHA or the NLRA.
  • You may not have been paying appropriate workers’ comp premiums.
  • You may not have given them the appropriate benefits notices and statements.

This list is not comprehensive. The government will be more than happy to tell you everything you have done wrong, and they will be happy to hand you a bill for your errors as well.

Some of the penalties

The penalties can add up pretty quick. According to netPolarityMisclassifying employees as independent contractors and failing to provide W-2 forms can subject an employer to back taxes of as much as 41.5%* of the contractors’ wages, according to the IRS. And these penalties can go back for three years.” If the IRS thinks you intentionally misclassified workers they may seek a criminal conviction with up to a year in jail and a fine as high as $500,000 for a corporation. Plus you get the label “tax evader.” The independent contractor themselves may be audited and may be forced to repay any business deductions they took during that time.

The US Department of Labor will require you to pay back wages for up to three years and will levy fines for improper recordkeeping. The company will also get an audit that may then uncover other wage and hour violations. Penalties can also be assessed.

State insurance agencies and departments of labor will also be seeking back payments on unemployment insurance and workers’ comp premiums. They will also be unhappy with the lack of recordkeeping and may levy fines.

Lastly, for those of you that have to comply with the Affordable Care Act, according to the attorneys at the Orrick Law Group, “…employer coverage responsibilities and the calculation of penalties for failure to provide compliant health coverage, depend on whether an individual is properly classified as an ‘employee,’ significantly increasing the adverse consequences of misclassification. To make matters worse, one misclassification may trigger the assessment of ACA excise tax penalties based on the employer’s entire full-time workforce.” They also point out that misclassification may alter the company’s insurance premiums since they are based on the health history of the covered employees.

Coordinated efforts to end misclassification

There is a coordinated effort on the part of several government agencies to clamp down on the misuse of the independent contractor classification. The USDOL and the IRS have a Memorandum of Understanding that is being spread to state governments. Not all states have yet signed on but that will only be a matter of time. Currently close to half of the states have enlisted for the battle against misclassification. If one agency finds out you have improperly classified independent contractors then they now pass that information on to other agencies. The “whammy” that comes from misclassification could easily end up being a triple or quadruple whammy and it becomes a very expensive mistake.

For more information and guidance read:

The IRS and HR: Who is an Employee?

Clamping Down on Misclassification of Independent Contractors

Using Independent Contractors just got riskier!

Photo credit: iosphere


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