“I’ll only hire independent contractors, so I won’t have to deal with taxes and overtime.”
If you have had that thought, you may be operating under the false assumption that you can call someone an independent contractor, or mutually agree to that title, when they are in fact employees subject to federal and state withholding as well as employer-paid taxes. Employees are also covered by overtime rules and entitled to workers compensation insurance coverage. You could have significant penalties imposed by the Internal Revenue Service (IRS) and other government agencies for the misclassification, even if it is unintentional.
What determines if a worker is an Independent Contractor?
The IRS publication covering the classification of employees and independent contractors says that the degree of control the employer exerts over the worker determines how they should be treated. When examining the overall relationship, factors that provide evidence of the degree of control exerted fall under three basic categories:
- Type of Relationship
Behavioral control looks to how the worker does the job. If the employer dictates where and when the individual works, as well as what equipment, tools and methods they use, then it is likely an employer-employee relationship. Conversely, if the worker is given an objective, but uses their own methods to achieve work results, then an independent contractor role probably exists.
Financial control looks at the worker’s right to control the business aspects of the work. If the worker has a significant investment in their own tools and equipment, incurs substantial unreimbursed business expenses, can advertise their services and work for more than one employer and/or gets paid a flat fee or on a time and materials basis, then an independent contractor relationship most likely exists. Independent contractors also have the risk of gain or loss on a job; employees typically do not.
The type of relationship that exists between the employer and the worker considers factors such as their agreement and the permanency of the relationship. If the relationship is contractual and will go on for a finite period, then it points to an independent contractor situation. However, if benefits such as insurance, vacation and sick pay are provided, then an employee relationship more likely exists.
What are the penalties for misclassification of employees?
If fraud or intentional misclassification is suspected, then the IRS may impose fines and penalties, including:
- 20% of employee wages paid
- 100% of both employer and employee FICA Contributions
- Criminal penalties of up to $1000 per misclassified employee
- Up to one year in prison
Employers who unintentionally misclassify employees can face fines for not properly classifying payments to workers as wages, including:
- $50 for each Form W-2 that should have been filed
- 1.5% of the employee’s wages, plus interest
- 40% of FICA (Social Security and Medicare) taxes not withheld from the employee
- 100% of the employer’s matching FICA contribution
In addition, the person responsible for withholding taxes could be held personally liable for uncollected taxes.
I’m not worried. I’ll never get found out.
Employers who misclassify employees as independent contractors get “caught” in a variety of ways. Federal and state agencies, including Department of Labor (DOL) and the IRS, perform random audits to uncover misclassified employees. Workers who believe they are misclassified may file a complaint with their state or the federal DOL. Sometimes workers who file a claim for unemployment or workers compensation will draw attention to the employer’s misclassification.
Given all of the above, it is a good idea to document the reasons for treating a worker as an independent contractor. The IRS provides Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding for employers to proactively get a determination of classification.
If you still have questions about properly classifying workers, our HR Support Services can provide the guidance you need to avoid unnecessary interest, penalties and worse.