Employees vs. Contractors: How to Avoid the Costly Consequences of Worker Misclassification

When building a team, classifying your workforce correctly is vital to your business’s success and legal compliance. Employees and independent contractors are not interchangeable terms, and it’s important that you can distinguish between the two in your organization.

While it may seem like a simple solution to classify members of your workforce as independent contractors, there are actually very specific criteria that determine whether a worker can be classified as an independent contractor. Workforce classification is not a grey area – the IRS has an independent contractor test, as do many states, and they do not always follow the same criteria. In this article, we’ll discuss the differences between an employee and an independent contractor so you can ensure you’re operating your business correctly.


When is a worker considered an Employee?

Employees work under your direct control – they follow your schedule, use your company tools, and often receive benefits such as training, healthcare and/or retirement. You withhold taxes from their paychecks and contribute your share of payroll and unemployment taxes, you pay workers’ compensation insurance on the wages, and you file quarterly and annual returns with the IRS, Social Security Administration, and state agencies.


When is a worker considered an Independent Contractor?

Independent contractors maintain autonomy – they work for themselves and have their own company, they set their own schedule, they provide their own tools, they have their own general and/or professional liability insurance, and they handle their own income and/or self-employment taxes and pay their own expenses. They are typically hired for a specific project and under contract and take the risk of whether or not they make a profit.


What can happen if a worker is misclassified as an Independent Contractor?

If the IRS determines that you have been misclassifying an employee as an independent contractor, the penalty can equal 20% of the wages paid; 100% of the employee FICA taxes that should have been withheld; 100% of the employer FICA taxes that should have been paid; 20-75% of the underpayment of taxes; 25% of the late payment of taxes; and a per-worker fine.

In addition, there are Department of Labor and state penalties for misclassifying employees as contractors, which can equal any overtime that should have been paid. Plus, courts can award an additional 100% of unpaid overtime payments.

Penalties can also include severe criminal sanctions, including felony charges.

There’s a lot at stake when it comes to classifying your workforce correctly, and cutting corners here can be a costly decision for your business. Proper classification safeguards your company from legal issues and ensures compliance with labor laws, workers’ compensation laws, and Federal and state laws. If you have questions about the classification of your workforce or need support with payroll in your business, reach out to our team at newbusinessdirections.com/contact.