Financial Risks of Employer Misclassification of Independent Contractors

While employer misclassification of independent contractors and W-2 employees has been an enforcement target throughout the entire Obama administration, the financial risks of misclassifying workers have increased rapidly thanks to the Department of Labor's (DOL) "Misclassification Initiative."

Why does misclassification matter?

The loss of tax revenue due to the misclassification of W-2 employees as 1099 independent contractors (IC) has been a significant problem for government agencies. When a company engages a worker as an IC, they don't pay the employer portion of taxes. This incorrect payroll tax withholding obviously takes money out of the government coffers. That is why the Obama administration has been cracking down on this practice.

Potential independent contractor misclassification penalties

Prior to the DOL's initiative, the IRS was the main enforcement arm of this crackdown. The DOL got into the act when it launched its Misclassification Initiative in 2011. Since then the DOL has collected more than $18.2 million in back wages for more than 19,000 workers. But it's not just the IRS and the DOL that employers need to worry about. The key to the Misclassification Initiative is the "Memorandums of Understanding" the DOL is signing with the IRS and state agencies. Under these MOU's, the DOL and the other agencies agree to share information about suspected misclassification. As a result, it is now more likely for employers to be penalized by a number of state agencies at once. This exposes them to a wide range of costs, including:

• Back taxes, failure-to-pay penalties, and late filing penalties
• Back pay, including overtime, and liquidated damages
• Back unemployment taxes and penalties
• Penalties for failing to pay Workers’ Compensation premiums
• Civil penalties (for example, in California, civil penalties can reach $25,000 per violation!)
• Penalties for missing I-9 forms (required for employees)
• Interest on back taxes
• Attorneys fees

How to avoid employer misclassification of independent contractors

Now more than ever, it does not pay to be involved in worker misclassification. If your clients have ICs, you may want to encourage them to audit their workforces. They want to make sure each and every IC truly qualifies for that classification. The best way to do that is to ensure all ICs meet the IRS guidelines, which can be found at Independent Contractor (Self-Employed) or Employee?You can also help them by offering to convert ICs to W-2 employees whose employment is outsourced to a contract staffing firm's back office support solutions. That way, they can still escape a number of the employment costs and administrative hassles without assuming the financial risks of misclassifying workers.