Employee Misclassification: The Real Cost of Not Knowing the Law

Kelli Horne
January 31, 2012 — 2,097 views  
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The importance of properly classifying workers as employees or independent contractors is critical. Seemingly insignificant work rules and requirements can change a worker's classification and failure to follow the legal guidelines for classifying workers can lead to extremely severe IRS penalties and potential litigation with workers. State and federal laws and lawmakers stay alert and on the look out for potential violators and if when located they are pursued vigorously.

If an employer fails to file 1099s on workers who are being treated as independent contractors the employer will receive a 3 percent penalty for failure to withhold taxes. In addition, the employer would owe the full employer portion of Social Security and Medicare taxes plus 40 percent of the employee's portion. If an employer has filed 1099s the penalty for misclassification can be cut in half, reducing the portion of penalty to 1.5%. However, they still would still owe the full employer portion of Social Security and Medicare taxes, but only 20 percent of the employee portion.

In some cases, employers may qualify for Section 530 Relief. Section 530 Relief exempts employers from penalties. To qualify however, a company must meet several criteria. Possibly the most important criteria is that the company must never have treated or classified any other worker performing similar duties as an employee. The company in question must also have filed all returns consistent with the classification and treatment. And finally, to be considered for relief, employers must be able to support a "reasonable basis" for the treatment and classification of the worker.It is important to understand that misclassification of a worker may go on for many years or for multiple employees. The penalties and taxes will be due for as many years as the employee worked for the offending company as an independent contractor. Because these are trust taxes, they attach personally to the employer and follow them permanently.

Differentiating between independent contractor status and permanent employment status can be difficult. Historically, employers have had difficulty distinguishing between the blurry liens. Even more troublesome is the fact that nearly every federal and state law may provide a different interpretation of what it takes to classify a worker as an independent contractor. Of course, the classification of employee versus independent contractor is of significant importance in that a whole host of potential obligations are affected, including, but not limited to: tax wage, worker's compensation and unemployment liabilities.

Unfortunately, perception often trumps reality. Making sure that worker terms, payment methods and environments follow a strict, appropriate method can help prevent potential trouble. Allowing any potentially inappropriate appearances in procedure or rules will help employers avoid unfortunate situations that can cost time, energy and money. And a company's reputation can be at stake as well. Keep appearances above board at all times.

Understanding the rules and regulations for employment classification is critical to making sure that workers are properly classified. Care should be taken with each employment situation and work environments and terms should be reviewed and adjusted regularly. Avoid penalties by doing due diligence upfront.




Kelli Horne

Kelli Horne is a freelance writer working for Horizon Business Solutions. If you're concerned about the classification of a current or future worker contact Horizon today at www.horizonbiz.com.