3 Ways Employee Misclassification Puts Your Business at Risk

By MBO Partners | February 10, 2022

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Key Points

As companies seek to remain agile and competitive by using a mixture of workers, it increasingly important to put measures in place to help correctly classify talent as either traditional employees or independent contractors.

If an IRS audit finds that a company is treating independent contractors like traditional W-2 employees, the audit can lead to large fines, back tax payment owed, and potential lawsuits.

Class-action lawsuits can drag on for years and result in large, ongoing costs.

Many organizations today incorporate independent professional talent into their fulltime workforce, making it increasingly important to put measures in place to help correctly classify talent as either traditional employees—recipients of a W-2 Wage and Tax Statement—or independent contractors—recipients of form 1099-MISC, Miscellaneous Income.

Failure to correctly classify a worker can have long-term, expensive consequences. If a person you engage does not fully qualify as a 1099 independent contractor as defined by the IRS and any applicable state laws, your business can be held financially responsible for any subsequent fines and penalties.

Here are three specific risks of employee misclassification.

1. Financial Penalties

The risk of being audited for worker misclassification has increased in the past few years with growing awareness of independent worker rights, more news coverage of high-profile misclassification lawsuits, and a growing conversation around how to interpret worker classification laws.

If an IRS audit finds that a company is treating independent contractors like traditional W-2 employees, the audit can lead to large fines, back tax payment owed, and potential lawsuits. No company is immune to audits, no matter their industry or size.

To minimize the risk of an audit it is first helpful to make sure that current classification practices are compliant. If your company does not already have a centralized program for independent contractor engagement, it is important to begin building one. A centralized program will help to consistently enforce policies that will help your company remain compliant and correctly engage independent workers.

2. Class-Action Lawsuits

Class-action lawsuits can drag on for years and result in large, ongoing costs. Not only are legal fees involved, but your company may end up owing punitive damages beyond individual or government fines and payments.

Lawsuits can also be costly from a workforce standpoint. When employees from various departments such as HR, legal, marketing, and finance take time to comply with investigations it takes away from their primary work responsibilities. Independent contractors may also view a company as an unfavorable choice in client partnership if they have been involved in a misclassification lawsuit.

3. Negative Publicity and Press

A big lawsuit that is covered by the press can quickly lead to negative publicity and reputation damage. Employees may not want to attach their name to a brand that has been involved in a well-known lawsuit, customers may begin to mistrust the company, and other businesses who may have been potential partners or investors down the road may choose to go a different direction.

Correctly classifying workers is not a straightforward task. MBO Partners has extensive experience in helping enterprises compliantly engage independent talent. Contact us today to learn how you can avoid costly misclassification issues.

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