Employee or Independent Contractor? Don’t Misclassify!

For quite some time, determining whether a worker could be classified as an employee or an independent contractor has been a bit of a gray area. It is estimated that in 2009 misclassification  cost the government 2.7 billion in underpaid federal taxes, workers comp and unemployment insurance and it is estimated that up to 30% of companies may still be incorrectly misclassifying workers as independent contractors rather than employees.

Intentionally misclassifying employees as independent contractors will result in serious penalties issued by the IRS or Department of Labor. Just recently, in the largest such enforcement action in California history, the state labor commissioner filed suit seeking $17 million in back wages, overtime pay and penalties from ZipRealty due to alleged misclassification of workers as exempt from overtime. Even unintentionally misclassifying an employee could result in the imposition of fines, penalties, back-taxes for which the employer is generally liable and even criminal prosecution. 

The 20 factor test has long been a guideline for small employers to use when assessing how to pay their workers, but some companies choose to ignore the 20 factor test and treat their workers as 1099 independent contractors. These companies do so at their own risk of running into trouble with the IRS and/or the Department of Labor. 

As of September, the IRS has announced a new program designed to reduce penalties for companies who have historically and unintentionally misclassified workers as independent contractors rather than employees. The new Voluntary Classification Settlement Program offers companies relief from penalties and some back payroll taxes if the company was audited by the Department of Labor and found to be incorrectly classifying workers.  Under the new provisions, companies who enter the program will not be subject to employee classification employment audit for previous years. 

There are many advantages for classifying a worker as an independent contractor if the type of arrangement allows it. Classifying workers as independent contractors relieves the employer of collecting and remitting employment related taxes. Even workers compensation insurance costs are the responsibility of the independent contractor. Additionally, employment related risks are reduced or eliminated.

Alternately, classifying workers as employees requires that the company withholds local, state and federal income taxes, and also pay half of the tax required under the Federal Insurance Contributions Act for Medicare and Social Security. Employees may also have rights to participate in any employee benefits, such as vacations, holidays and retirement plans, which may create additional expenses for the employer.

For companies who cannot treat workers as independent contactors or who have decided not to, outsourcing their employment to a PEO offers the best of both worlds. Partnering with a PEO offloads the responsibilities of full IRS compliance. PEOs deliver the advantages of having employees, but without the risks associated with treating workers as independent contractors. 

Does your company need help finding a PEO in your area, or have questions about correctly classifying your workers? Contact us  today for ways to ensure compliance and operate more efficiently by offloading your administrative responsibilities.

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