Stakes Getting Higher for Independent Contractor Misclassification

Even with years of increased enforcement, 1099 independent contractor (IC) misclassification is a common employment violation.  And the risks associated with contractor misclassification are only increasing as government agencies coordinate their enforcement efforts.  Companies look to recruiters as employment experts, so it is important you know the basics of proper worker classification and stay on top of the latest enforcement efforts.

Why Misclassification Happens

When companies classify workers as ICs, they don’t pay the employer share of FUTA, SUTA, and FICA taxes for ICs.  They also don’t pay Workers’ Compensation or offer ICs benefits.  Companies can save approximately $3,710 annually on each $20/hour worker in FUTA and FICA taxes alone by classifying them as ICs, according to the Treasury Inspector General for Tax Administration (TIGTA).  When you add the employer cost of Workers’ Compensation and benefits for a W-2 EE, the financial impact is dramatic.

Some workers also prefer the IC classification due to tax advantages, including the ability to write off business expenses on their tax returns.

It’s NOT the Client or Candidate’s Decision!

But the proper classification is NOT up to the worker, the client, or the recruiter.  The IRS guidelines dictate how they are to be classified based on a number of factors that fall into three main categories:

1. Behavioral control—If the company provides training and instructions about when, where, and how to do the work, they have maintained the right to control, so the worker is likely a W-2 EE.
2. Financial control—If the company reimburses expenses, provides tools and facilities, pays the worker by the hour, or is the person’s only source of income, they may be found to have financial control, making the worker a W-2 EE.
3. Type of relationship—Facts showing the tie between the parties, including (1) written contracts, (2) whether the worker receives benefits, (3) the duration of the work, and (4) the extent to which the services are an aspect of the company’s regular operations.

For more information, go to http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Independent-Contractor-Self-Employed-or-Employee

Misclassification Enforcement

IRS misclassification audits are widely feared by employers.  But the IRS isn’t the only sheriff in town.  The government has collected more than $9.5 million in back wages for more than 11,400 workers in the past two years.  Through its Misclassification Initiative, the Department of Labor (DOL) has hired 350 investigators and has signed Memorandums of Understanding to share information with the IRS and 14 states.  This significantly trumps up the financial ramifications for misclassifying workers, including:

• Back taxes, failure-to-pay penalties, and late filing penalties
• Back pay, including overtime, and liquidated damages
• Back unemployment taxes and penalties
• Penalties for failing to pay Workers’ Compensation premiums
• Civil penalties (for example, in California, civil penalties can reach $25,000 per violation!)
• Penalties for missing I-9 forms (required for employees)
• Interest on back taxes
• Attorney fees

Don’t assume that you or your clients are too small to be noticed.  These “red flags” can set the government’s sights on even the smallest companies:

• The 1099 IC files a claim for unemployment benefits.  (They are not eligible for unemployment.)
• The 1099 IC files a claim under the company’s Workers’ Comp policy.  (They should carry their own WC coverage.)
• The 1099 IC receives a W-2 AND a 1099 from the same company in one year.
• The 1099 IC feels they are improperly classified and files a complaint with the DOL.
• The IRS is anonymously alerted about the worker or the employer not paying taxes.

As you can see, worker misclassification is risky.  Encourage clients to audit their workforces to ensure their ICs are properly classified.  You can help by offering to convert their 1099 ICs to W-2 EEs and outsourcing the employment of those workers to a contract staffing back-office.  That way, your clients can still receive the value their workers provide without the administrative and financial burdens of employing or the risk involved with making them ICs.