Businesses that erroneously (and sometimes intentionally) classify workers as independent contractors run the risk of incurring significant penalties if they are audited or reported by disgruntled “contractor-would-be-employees.” In addition to underpaying their share of employment taxes, these employers effectively deny benefits to deserving employees, including overtime pay, family medical leave, unemployment insurance and workers compensation. Improperly classified employees end up paying their own health insurance and the full FICA tax. This also imposes a financial and competitive disadvantage on law-abiding employers who correctly classify their employees and appropriately pay their employer taxes, insurance and other expenses.
The Internal Revenue Service (IRS) has been engaged with the Department of Labor’s (DOL’s) Wage and Hour Division (WHD) in a “Worker Misclassification Initiative” to detect and discourage wrongful misclassification of employees as contractors. Business owners should be aware of the conditions put forth in this initiative, such as requiring employers to:
Conditions promulgated by the DOL (the “Economic Realities” test) and the IRS (3 factor test) can help employers correctly differentiate between employees vs. independent contractors. Factors to be considered include:
As an employer, you can take proactive steps to audit the classification of employees before the Department of Labor or the IRS does it for you. Steps you should take include:
The key is to respond proactively as an employer. Do not assume you won’t be challenged by workers or targeted by authorities from the DOL or IRS. All it takes is an unhappy worker who files a complaint with the federal or state DOL. Maybe a worker files a claim for unemployment or workers compensation, which draws attention of the authorities. Then you will wish you had dealt with the classification issue appropriately.
For more information and guidance about the appropriate classification of employees and contractors, check out HR Support Center.
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