Independent professionals provide access to high-quality talent, staffing flexibility, and cost savings, so it’s no surprise that use of this talent pool has become more common in recent years. However, one of the biggest risks in utilizing independent talent is misclassifying employees as independent contractors.
When workers are classified as independent contractors, organizations avoid paying the benefits that most employees are entitled to such as health insurance, paid time off, and the employer’s side of payroll taxes. As awareness of independent worker rights grows, so have high-profile misclassification lawsuits and heightened security from government agencies.
The IRS is alerted of potential misclassification in several ways. A misclassification whistleblower may file an SS-8 form, receive a 1099 and W-2 in the same year, or try to claim unemployment or disability which results in an audit of the business.
Regardless of whether or not misclassification is intentional, it puts organizations at risk for owing back taxes, benefits, and penalties for its misclassified workers. Here are five consequences of employee misclassification and what your company can do to remain compliant.
There are a variety of tests that exist to determine whether or not a worker should be classified as an employee or an independent contractor. The federal government, state government, and government agencies all apply different tests to determine classification, and these tests lack uniformity. This complicates the hiring and vetting process as independents can be categorized as employees under one law, but as contractors under another.
Unfortunately, this can make legal compliance difficult. If employers misclassify employees, they may be violating wage, tax, and employment eligibility laws.
Organizations can be held liable for failing to pay overtime and minimum wage under the Federal Fair Labor Standards Act (FLSA) as well as under state wage laws. Wage claims may go back as far as three years if a willful violation is found—when an employer knowingly violates the law.
When an employee is misclassified, federal and local government lose out on tax and payroll revenue. Employers may be responsible for paying state and federal payroll taxes as well as Social Security and Medicare taxes for all employees found to be classified incorrectly. Penalties can also be imposed for failing to timely deposit payroll taxes.
Lastly, organizations must keep I-9s for each of their employees on record to prove their employment eligibility. If an independent contractor should’ve been classified as an employee, there are fines associated with not having an I-9 form on record for that worker.
Fines from the U.S. Department of Labor (DOL), IRS, and state agencies can total millions of dollars. Organizations can be held responsible for paying back-taxes and interest on employee’s wages as well as FICA taxes that weren’t withheld originally. Failure to make these payments can result in additional fines.
If the IRS believes you’ve intentionally misclassified workers, there is also the possibility of criminal and civil penalties and sanctions. Additional penalties and fines can be applied depending on the severity of the misclassification.
The media today is filled with ongoing class action lawsuits involving large, well-known organizations. These lawsuits can result in huge costs for your company—not only legal costs, but also punitive damages, compensation that goes above and beyond individual or government fines and payments.
When a company is involved in a lawsuit, representatives from legal, HR, marketing, and finance departments will need to assist in finding proper documents, defend claims, and comply with investigations. During this time, these key people will not be able to dedicate as much time to their primary work.
Loss of existing talent is also a potential consequence. Independent professionals may decide to end their relationship with your company, or choose to not reengage with you when their project ends.
If a worker believes they’ve been misclassified, they can file a complaint with their state Department of Labor or with the DOL. If these claims are validated, workers are eligible to claim employee benefits including 401(k) severance, health and welfare coverage, stock purchase plans, and even overtime, PTO, and rest brake time. This can result in additional fines and penalties as well as increased scrutiny from tax and labor authorities.
Not only can misclassification hurt your workers and your bottom line, but it can also damage your organization’s reputation. An audit or lawsuit can put your company in the public eye, which can lead to negative publicity that can damage recruitment efforts and the overall reputation of your brand.
Independent professionals may be hesitant to work with your organization if they know you’ve been involved in a misclassification lawsuit, and other businesses may shy away from partnerships due to negative media attention. Correcting reputational damage can be complicated and time consuming, slowing down operational efficiency and disrupting talent pipelines.
Misclassification carries serious penalties, risks, and consequences, so it is essential that organizations have a classification process and policies in place for hiring and managing independent professionals. It’s important to properly classify workers to the best of your ability and to always have a written contract that includes specific provisions to protect your company.
Firms that specialize in independent contractor engagement and compliance can assist in properly developing these policies and setting up a program for proper management of independent talent. MBO Partners has an established methodology for evaluating and engaging independents, which minimizes or eliminates compliance issues.
For more information on misclassification and compliance, contact us today.
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