It is estimated that 10 to 20 percent of employers misclassify at least one worker as a contractor rather than as employee. Both old and new-economy sector workers are impacted, in industries like trucking, construction, house cleaning, in-home care and technology, as well as those in the “gig” economy (Lyft, Doordash and the like). The employer’s incentive is lower labor costs, but the practice means these companies evade Social Security, Medicare, unemployment and other tax obligations. They also avoid covering their misclassified workers for workers compensation and unemployment insurance.
The reduced labor costs give them an unfair competitive advantage versus the legally compliant business owners. The practice also shorts revenue collection for the federal and state governments – several studies conservatively estimate the shortfall at over $3 billion annually – which shifts the tax burden to law-abiding taxpayers. And the workers find themselves without the legal protections afforded employees for wages and overtime, unemployment insurance if they find themselves out of work, and workers compensation coverage if injured on the job.
The net result of being found out, whether through a worker filing a complaint with a state labor agency, or a workers compensation or unemployment claim being filed which alerts those agencies, is that significant fines and penalties can be levied on the company. Plus, the individual(s) responsible may find themselves personally liable for the uncollected taxes.
Here are the potential penalties associated with misclassifying an employee:
1. Employer Fines and Back Payments
Even in cases where misclassification is unintentional, an employer can face fines including:
- A $50 fee for each Form W-2 that should have been filed
- 1.5% of the employee’s wages, plus interest
- 40% of the employee’s FICA (Social Security and Medicare) taxes that were not withheld from the employee
- 100% of the employer’s matching FICA contributions
However, if intentional misclassification is suspected, an employer can be charged these fines and penalties:
- 20% of all employee wages paid
- 100% of FICA contributions for both employee and employer
- Criminal penalties of up to $1000 per misclassified employee
- Imprisonment for up to one year
As noted above, the individual responsible for the misclassification may be held personally liable.
2. Employee Benefits Owed
A misclassified employee who files a complaint may be eligible for benefits owed to them, such as:
- 401(k) or pension plan contributions
- Health insurance
- Disability insurance
- Stock options
- Vacation Pay
- Sick Leave
- Break Time
3. Damage to the Company Name and Reputation
If the fines and penalties aren’t enough, costly lawsuits can be a financial drag on the company and result in punitive damages. The time, attention and focus of management are diverted from growing the business to salvaging it. Bad publicity stemming from lawsuits and possible media coverage, including social media, can do irrevocable harm to the company’s and the owner’s reputation.
In short, employee misclassification can cost employers a great deal. Compliance with governmental tax, labor and insurance regulations is a relatively small price to pay for the legal coverage, and peace of mind, it provides.