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Employee or independent contractor -- and why does it matter?

Employers are required to pay all employees time-and-a-half once they hit 40 hours in a given workweek, right? Well, not necessarily.

In fact, both federal and Maryland law carve out several exceptions to the overtime rules, including situations involving certain salaried employees as well as "independent contractors."

What is an independent contractor?

From an employer's perspective, there are many benefits to hiring independent contractors over regular employees. For instance, employers often save money with independent contractors since it means the employers don't have to cover certain employee-related expenses, including workers' comp insurance, employee benefits as well as the employer's share of Social Security and Medicare taxes. In addition, independent contractors are not entitled to time-and-a-half overtime pay.

However, it is important to point out that employers simply cannot label a worker an "independent contractor" in order to save money when the worker is actually considered an "employee" under the law. Simply put, workers must be classified correctly.

Below are a few of the questions that are sometimes asked when determining whether a worker should be classified as an employee or an independent contractor:

  • Does the employer have the right to control and direct the worker? For example, if the employer controls not only "what" needs to be done, but also "how" it should be done, then the worker is more likely to be considered an "employee."
  • Does the employer have the right to discharge/fire/terminate the worker's employment at any time? If so, then the worker is more likely to be considered an "employee."
  • Does the employer furnish the tools, materials and work location? If so, then the worker is more likely to be considered an "employee."
  • Does the employer have the right to dictate the hours and days the worker must be working? If so, then the worker is more likely to be considered an "employee."

Keep in mind, however, this the list above is by no means an exhaustive one. Also, many factors are typically considered in any given situation, meaning no factor, by itself, is controlling.

What if the employer gets it wrong?

While an employer may be tempted to classify workers as independent contracts to save money, it can cost them much more down the road if they are wrong. Indeed, misclassifying an employee as an independent contractor can result is several penalties, even if the misclassification was unintentional. These penalties may include:

  • Back taxes: Since the employer didn't withhold any taxes, it may need to pay back taxes on the employee's wages, plus 40 percent of the employee's FICA contributions and 100 percent of the employer's matching FICA contributions.
  • W-2 Fee: An employer may also be required to pay a fee for every W-2 that wasn't properly filed.

And if the misclassification was intentional, the employer may face even more severe consequences, including:

  • A penalty of 20 percent of all wages paid
  • A penalty of 100 percent of all FICA taxes (meaning both the employee's and employer's share)
  • A criminal penalty of up to $1,000 per misclassified employee
  • A possible jail sentence

In addition to the penalties listed above, the misclassified employee may also file a complaint against their employer seeking a wide range of damages, including overtime pay, paid time off and retirement account contributions, just to name a few. Ultimately, misclassifying an employee as an independent contractor can cost an employer millions of dollars.

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