Employee Misclassification As Independent Contractors Can Be Extremely Expensive

September 29, 2022

As more companies realize the advantages of employing independent contractors (ICs) rather than full-time workers, the boundary between worker classifications may quickly become blurred. While understanding the two may be challenging, getting it right can be one of the most critical business choices you’ll ever make.

Misclassifying your employees may cost you a lot in terms of productivity and your bottom line, as well as fines, back taxes, and unpaid benefits. What’s more, the Department of Labor (DOL) recently rescinded a Trump-era rule that would have made it easier for employers to designate workers as independent contractors, rather than employees under the Fair Labor Standards Act (FLSA).

A more cautious approach to independent contractor relationships under the Biden administration may mean that more people will be classified as employees rather than contractors. In fact, as a candidate for president in 2020, Biden pledged to establish a federal standard for worker classification similar to the “ABC test, which was recently adopted in California.

In a subsequent article, we’ll go through the changes in the law that have affected worker categorization, but for the time being, you should make sure you’re doing all you can to ensure accurate classification.

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Common Mistake

Studies show that between 10% and 20% of employers misclassify at least one employee, and you can be penalized regardless of whether or not you did so intentionally. Due to the high rate of misclassification, you should carefully evaluate every team member before hiring them and have solid employment agreements in place for everybody you hire.

Fortunately, you may simply avoid these dangers and remain fully compliant with the help and advice of your lawyer. Since employing independent contractors (ICs) instead of workers saves you a lot of money, you may be tempted to take a risk and pass off some of your employees as independent contractors.

But in doing so, you’re risking serious consequences, which have the potential to ruin your business.

Ways in which Companies Get Caught

It is very simple for the IRS to be informed of potential misclassification. A team member may submit an SS-8 form claiming that you have violated the law, or he or she may just get a 1099 and a W-2 in the same year.

Additionally, you may be caught if a member of your team attempts to file for unemployment or disability, which may result in an audit of your business.

Also, since there’s no single test at the federal level for determining a worker’s classification and state requirements differ, it is possible to misclassify someone by mistake. And regardless of whether the misclassification was intentional, if the allegation is shown to be true, you may be liable for back taxes, benefits, and hefty fines.

Fines, Back Payments, and Penalties

Fines from the DOL, IRS, and state agencies of up to millions of dollars may be charged if you misclassify an employee. Additionally, you may be liable for back taxes, interest, and FICA taxes that were not initially withheld on employee earnings. Failure to pay these fees will result in more fines. The FLSA and state regulations also hold you responsible if you fail to pay your employees overtime or the minimum wage. It’s possible to make such claims for a period of three years in the past if you knowingly made the misclassification. Also, if the IRS determines that your misclassification was intentional, you may be subject to criminal and civil penalties.

Apart from the penalties paid to state and federal authorities, a misclassified employee is entitled to recover employee benefits that he or she missed. Employees’ perks are health insurance, stock options, 401(k) matchups, paid time off, and even unpaid breaks. If an employee is misclassified, the audit and fines that follow may be very damaging to your company’s reputation. Even if the fines and penalties don’t completely destroy your business, the negative publicity just might.

Avoid Taking A Chance

While using independent contractors may offer your business an advantage in today’s “gig economy,” ICs can also be a serious risk if you are not cautious. Consult your lawyer for trustworthy advice on your state’s most recent worker classification laws and support in creating binding independent contractor agreements that protect both your business and its intellectual property.

This article is a service of Greg Gordillo, Family Business Lawyer™. We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Schedule your LIFT Session today!

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