Hi, it’s me again. In my previous blog, I disclosed that I am not a lawyer and that the advice/commentary in this blog should not be construed as legal advice. I referenced the IRS definitions and circumstances which clearly define when someone would be considered an independent contractor or an employee in order to help clarify the confusion surrounding independent contractors.
Since Covid-19 is reshaping how we work, how/who we employ, I felt it beneficial to make this information available to my peers. With 10 years of independent contractor/business owner status, I feel “seasoned” enough to share. Remember, this is my personal opinion and interpretation of the public information made available on the IRS website and other valuable resources. In order to feel confident about sharing this information, two uniquely different yet equally qualified lawyers have reviewed my blog content to ensure I was not putting untruths out into the interwebs. Moving on…
Why the confusion surrounding independent contractors.
In the introductory blog, I shared the IRS definitions of independent contractors and employees. But as the business owner, as well as the independent contractor, you’re responsible for knowing the difference and protecting your livelihood. If the two parties have different impressions or if there is a mystery surrounding the contract, it’s best to resolve that situation ASAP. Both business owners and independent contractors should seek legal counsel to ensure best interests are protected.
It’s imperative before continuing to make two things crystal clear:
- I am not referring to an independent contractor hired in for a specific project or task. I am referring to an independent contractor who is hired by a business under the guise of multiple responsibilities and extended “employment”.
- I am referring to business owners who either plead ignorance or simply ignore the differences between an independent contractor and an employee. Continue reading to learn why it’s important to have clearly defined roles and responsibilities outlined in contracts and communicated/agreed upon by both parties.
Unfortunately there are business owners out there that engage in the unprofessional, underhanded and down right wrong practice of hiring independent contractors but treating them like employees. Why would any business owner knowingly engage in conduct like that?
Why do employers misclassify employees?
According to the website www.JustWorks.com, the answer is money. By classifying a worker as an independent contractor instead of employee, an employer avoids the following expenses:
- Employer’s share of Social Security and Medicare taxes
- Overtime pay
- Employee benefits, including vacation, holiday, and sick pay
- Unemployment compensation tax
- Workers’ compensation insurance
What are the penalties for misclassifications?
The following text is shared from Just Works – a resource designed to help entrepreneurs and businesses grow with confidence.
How do businesses get caught? One way is when a worker who believes they have been misclassified as an independent contractor files a complaint with either their state Department of Labor or with the U.S. Department of Labor (DOL). Another way is when a worker who has been classified as an independent contractor files for unemployment benefits, or is injured while working or driving for work and tries to file a workers’ compensation claim.
Also, state and federal government agencies perform regular audits looking for workers who have been misclassified as independent contractors. Both the DOL and the IRS are focusing their audit work on independent contractor misclassification. A DOL or IRS audit will typically include all employees and independent contractors for a three-year period.
The ramifications for an employer can vary depending on whether or not the DOL and the IRS determine the misclassification was unintentional or intentional, or even fraudulent.
An estimated 3.4 million employees are classified as independent contractors when they should be reported as employees.
If the misclassification was unintentional, the employer faces at least the following penalties, based on the fact that all payments to misclassified independent contractors have been reclassified as wages:
- $50 for each Form W-2 that the employer failed to file because of classifying workers as an independent contractor.
- Since the employer failed to withhold income taxes, it faces penalties of 1.5% of the wages, plus 40% of the FICA taxes (Social Security and Medicare) that were not withheld from the employee and 100% of the matching FICA taxes the employer should have paid. Interest is also accrued on these penalties daily from the date they should have been deposited.
- A Failure to Pay Taxes penalty equal to 0.5% of the unpaid tax liability for each month up to 25% of the total tax liability.
If the IRS suspects fraud or intentional misconduct, it can impose additional fines and penalties. For instance, the employer could be subjected to penalties that include 20% of all of the wages paid, plus 100% of the FICA taxes, both the employee’s and the employer’s share.
Criminal penalties of up to $1,000 per misclassified worker and one year in prison can be imposed as well.
An independent contractor does not affect the amount of taxes a business pays like an employee does. Businesses save when all the work is being performed by individuals who have no paid vacation, sick and/or personal time, no access to health insurance and last but certainly not least no employer retirement contribution. As an independent contractor, you are financially responsible for accounting for and paying the full chunk of required taxes. There are no retirement benefits, no company benefits, no bonuses. It is important that a business understand the ramifications of using independent contractors and it is equally important for the independent contractor to fully understand the legalities involved in the working situation. Regardless of what words are used in the contract, the Department of Labor and the IRS still have very specific descriptions on what qualifies as an employee.
It takes TWO to Tango.
The onus can not solely be put on business owners though. Regardless of how business are operated, the worker shares in the culpability as well. If a worker at a business is labeled as an independent contractor, but is being treated as an employee, it’s up to the worker to remedy that situation. Having clear communication, a transparent contract and proper legal counsel is necessary and can reduce role confusion.
Contractors should not shy away from the need to reevaluate contract terms, workflow, expectations and price on a regular basis to ensure a good working relationship between both parties. Whether an innocent mistake or an intentional decision, there is a strong responsibility on ANY business owner to build their business with integrity, not to mention obeying tax laws. Words like “audit” “repayment of back taxes” and “prison time” can be eye opening.
Still confused, upset, concerned and frustrated? Contact your accountant, your legal counsel, or financial advisor to help you navigate the waters of hiring a full time employee or to determine if a contractor is what your business needs. The change in our workforce does bring up interesting and sometimes stressful things to consider, but it doesn’t have to impossible. Evaluate the current state of your business, determine your long term goals, double-triple check the finances and analyze your current production load. Oh, and stay on the right side of the law.