Today’s post, in keeping with many of you observing Hallowe’en today, covers a scary topic for many businesses. Suppose you own a company and you have many people working for you. Some of them you treat as employees. You had them fill out a W-4 on their date of hire and you are sure to make the proper payroll deductions. You offer health insurance, paid time off, a 401k and the like. Now suppose you recently hired a group of workers that you did not wish to put on your payroll or be subject to all the laws and administrative costs that apply if you are their employer; maybe those workers did not want to be on record as your full-time employees either. , You therefore call them independent contractors. You send them a 1099 at the appropriate time and you are done — or so you think . You may have misclassified those workers. So what?, you think. If the workers are happy and I’m happy, what’s the problem, who’s hurt? The problem is that you may be in violation of federal and state laws and the penalties can be steep. Let’s start looking into this topic after the jump…
Why do the federal and state governments care how you classify your workers? If a government agency gets involved, you can always assume that the answer, at least in part, will be “money”. Often it will also have to do with protecting people who are or are perceived to be vulnerable to exploitation of some sort , which ends up affecting the state and federal pocketbook–bringing the answer back to “money”. Unlike employee, workers classified as independent contractors do not have access to key benefits, such as minimum wage, workers’ compensation, unemployment insurance benefits, family and medical leave and overtime pay, to name a few. The PPACA (aka “Obamacare”) adds a new layer to this issue. Since the business that utilizes the workers is not ensuring payroll deductions to withhold for taxes, the Treasury, Social Security and Medicare and state unemployment and workers compensation funds lose money.
Consequently, the federal and most state governments have been stepping up their efforts to crack down on businesses that misclassify their workers. Specifically, in 2011, Vice President Biden convened a Middle Class Task Force, under whose auspices the US Department of Labor has launched a Misclassification Initiative. Secretary of Labor Hilda Solis announced in September 2011 that the DOL and the IRS signed a Memorandum of Understanding (MOU) in which both agencies have agreed to work together and share information in order to reduce occurrences of misclassification, reduce the tax gap and improve compliance with federal labor laws. No business wants to be on either of these agencies’ radar screens–and you certainly do not want to be a target of both at the same time! That’s not all: As of now, the US DOL has MOU’s with at least 14 state Labor Commissioners and is actively pursuing MOU’s with other States. Bottom Line: If you have improperly classified any of your workers as independent contractors, the federal and maybe your state government will likely come after you.
What are the potential penalties for such misclassification? Some of that, of course, will depend on the specific circumstances. Here are just a few: For starters, misclassification can result in back taxes to the IRS of as much as 41.5% of the worker’s wages per year —and that can go back as far as three years. While the extent of the penalty will depend in large part on whether the misclassification was intentional, penalties do exist for unintentional misclassification. For example, the IRS imposes a $50 fine for each W-2 a business should have filed but failed to file on behalf of a worker. Similarly, a business can be subject to a $50.00 fine for each worker for whom it should have obtained a social security number but did not do so. The IRS can also impose penalties of $1000 or up to one year in prison per violation for businesses that fail to withhold the proper amounts from a workers’ wages for taxes. $1000 per violation can start adding up to significant dollars for businesses who have routinely engaged in such a practice over a long period of time. Officers and employees with authority over financial affairs can be held personally liable for up to 100% of the back taxes. These are just IRS penalties! We have not even looked at other agencies, such as DOL who will also get into the act! The US and in some cases State DOLs will go after such businesses for back wages or the value of benefits they determine the worker(s) should have received. Again, these are not all the scary prospects waiting out there for those who improperly classify their workers.
There are a few misconceptions out there about this issue —and too many businesses are misled by them. Here are some:
- We had a signed contract in which the worker agreed that s/he is an independent contractor, so I’m OK, right? No, no, no, no!!!! Wrong answer! Do not pass “Go”. Do not collect $200.00. This is one case where your contract language, is not likely to define your relationship. What determines the worker’s status? The actual working relationship, i.e. how the business and the worker conduct themselves will determine the relationship. Next week’s post will get into the factors considered in determining whether a worker is more likely an employee or independent contractor
- It’s the Industry Standard, so I’m OK, right? Don’t get too comfortable here! In order to use the “industry standard” argument, businesses actually have to document how they came to that conclusion and show what evidence they relied upon. If you choose this route, you must show studies, surveys or other informed evidence showing that classifying the workers in question as independent contractors is the standard in your industry.
- I can classify workers in a probationary period as Independent Contractors and then, if I am satisfied with their performance, I can make them employees: Here is the problem with that approach. Your actual relationship has not changed and the IRS will now see that you have issued both a 1099 and W-2 for the same employee who did the same work for you and with whom the realities of your relationship did not actually change. Uh oh! You are now at risk of being flagged by the IRS — and other agencies with whom it is now collaborating.
- I can classify part-time workers as independent contractors, right? Nope. Sorry. Wrong again. To the extent that part-time workers are doing the same work as your full-time workers, that will not work. I’ll talk more about why in next week’s post.
- If the worker runs his or her own independent business s/he is definitely an independent contractor though, right? The answer here is a definite maybe! Why? Again, it will really depend on the realities of how the worker and the business hiring him or her relate to each other and the nature of the work being performed among other factors.
- Workers who do not work on my premises do not have to be classified as employees, do they? Yes, they often do. Where they work is not the operative question. What type of work are they doing, and — sorry to sound like a broken record — the realities of how you and they relate to each other determine the worker’s status.
Well, for those of you who get into Hallowe’en, have I scared you enough for today? Can anyone ever be an independent contractor? Yes it is possible. Come back next week and we will discuss the factors to consider in determining when someone is an independent contractor and when they must be classified as an employee. Don’t eat too much candy!
Disclaimer: Contents of this post are for informational purposes only, are not legal advice and do not create an attorney-client relationship. Always consult with competent local employment counsel on any issues discussed here.
Click here to learn more about Janette Levey Frisch, author of The Emplawyerologist.
“Like” The Emplawyerologist on Facebook, by clicking here.
Would you like to be a guest blogger? Email The Emplawyerologist at email@example.com
Click here to hear my guest appearance on Legalocity about the recent US Supreme Court case, Vance v Ball State University, a case dealing with workplace harassment allegations