Are You Going to Jail for Misclassifying Employees as Contractors?

Posted on: June 23, 2020

Without a doubt, there are financial incentives for companies that classify employees as contractors. Employers do not have to cover health insurance, compensate for extra hours, or pay certain taxes. Unfortunately, these benefits fade quickly when the taxing authorities come knocking.

As we have discussed in previous posts, when you classify an employee as a contractor, you are not liable for federal tax withdrawal, paying unemployment taxes, paying insurance for the worker, or complying with wage and hour rules. However, misclassification means that you’re violating each of these laws.

We have seen the amounts of audits by taxing authorities increase in the past few years specifically looking for the misclassification of employees. They look for underpaid income taxes from the employee and payroll taxes from the employer. Employers caught misclassifying employees end up owing both halves of Social Security taxes, unemployment taxes, and other relevant taxes for the period examined, not to mention that there may be additional penalties from the IRS and employment regulators. Other debts that may be owed are insurance premiums, unpaid wages, overtime compensation, and late fees as applicable.

A question we often get is, “If I don’t file a Form 1099, how will the IRS know?”  Well, when your business return is filed there are two questions that must be answered to file the return: did the taxpayer make any payments that would require filing a Form 1099, and did they file the Form 1099?  If the answers are “yes, payments were made” and “no, they didn’t file” – your return can quickly become a red flag, and an easy target for audit!

In addition, class action lawsuits against employers for misclassifying employees as contractors are nothing new. However, with changing work relationships and the advent of the “gig economy”, employers are increasingly finding the line between employees and contractors as starting to blur. Thanks to technological improvement, non-traditional jobs are proliferating in the modern workspace and employees can work remotely from any part of the world.

Therefore, you may also find yourself battling class action suits for wage and tax violations. These claims may come from individuals, groups, or be part of a state class action against your business. Court proceedings can consume more of your time and money, and if the plaintiff wins any of the cases, prepare to pay an even larger sum in damages to each of the wronged parties.

Recently, there has been an upsurge in the misclassification of employees by employers who are either seeking to reduce their financial burden or have workers in gray areas. For example, companies with business models that rely on independent contractors, such as rideshare companies, goods delivery, and tech start-ups, often find themselves in trouble as these newer industries evolve with the demand of their consumers.

The best way to avoid misclassifying employees as independent contractors is to understand the differences between independent contractors versus employees, seek professional assistance, and build your business’s internal process around the appropriate framework. Doing the right thing from day one reduces risk and builds a strong foundation for your business going forward.

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