With the "gig economy" in full swing, state and federal agencies have an incentive to scrutinize whether workers are properly classified as independent contractors or employees. After all, employers are not responsible for paying half of an independent contractor's payroll taxes or the unemployment insurance and workers' comp required by law. And, independent contractors lack many workplace protections that employees are entitled to receive.
The question of whether a worker is a statutory employee or an independent contractor is a legal one, largely determined by the federal Fair Labor Standards Act and corresponding state laws. Employers don't simply choose which classification is most convenient, but must have a reasonable basis to believe the worker is classified properly.
Improper classification of a worker as an independent contractor can lead to a number of issues:
- You may not have kept accurate records of the worker's time, as required by law.
- You may not have paid required overtime.
- You may not have complied with the Affordable Care Act.
- You may not have paid the appropriate payroll taxes or contributed to workers' comp and unemployment insurance.
- You may not have paid discretionary benefits or made appropriate contributions to the workers' retirement plan.
- You may not have accorded the worker appropriate protections under the FLSA or other laws.
- You may not have withheld the appropriate taxes for the employee.
- You may not have filed the appropriate federal, state and local tax forms.
If you are found to have misclassified an employee as an independent contractor, the U.S. Department of Labor Wage and Hour Division could assess penalties such as back wages for up to three years or liquidated damages of twice the actual impact of the misclassification.
The IRS can also assess penalties for misclassification, and the agency is actively monitoring the issue, according to the Associated Press. If you fail to pay payroll taxes for an employee who was misclassified as an independent contractor, you could be liable for the full amount of payroll taxes that were due, along with possible penalties and interest.
If the IRS determines you had a reasonable basis for the misclassification, you could be relieved from the requirement to repay the back taxes, in some circumstances. Additionally, there is a Voluntary Classification Settlement Program available that allows employers to reclassify their workers as employees for future tax periods and get partial relief from any federal employment taxes you owe.
The best way to protect yourself from misclassification issues is to properly classify your workers in the first place. An experienced employment law attorney can help you understand the DOL and IRS classification rules and how they apply to your workers.