Most businesses have figured out that W-2 employees must have taxes deducted from their paychecks, and that the business must remit a variety of employee and employer taxes to various governmental authorities on behalf of each of its employees. This means that the employer must keep track of the taxes that are deducted from each employee’s paycheck and remit those taxes to the appropriate taxing authorities along with the employer’s share. In contrast, an independent contractor is paid all earned compensation, with no deductions for taxes – and the employer need not remit any “employer’s” share of taxes either. So it is tempting to classify a worker as an independent contractor in order to (1) avoid paying the employer’s portion of the employment taxes, and (2) eliminate the extra paperwork that flows from keeping track of employment taxes. It is not unusual for a business to misclassify employees as independent contractors, either deliberately or simply out of ignorance as to the distinction.
Other articles on this website address the specifics of the distinction between employees and independent contractors, but the analysis really boils down to the level of control exercised over the worker. The more control the business exercises over the worker’s work schedule, method of performing assigned duties, tools used, work location, etc. – the more likely it is that the worker must be classified as an employee. Where the worker is simply given a task to complete, a pay rate for the task, and instructions to complete the task as the worker sees fit by a specified deadline, it is more likely that the worker will be deemed to be eligible for independent contractor status.
There are two federal agencies that take a keen interest in ensuring that businesses properly classify their workers: the U.S. Department of Labor’s Wage & Hour Division and the IRS.
The Department of Labor’s Wage & Hour Division is charged with enforcing the nation’s overtime laws. If a worker is misclassified as an independent contractor and instead should be classified as an hourly employee not exempt from being paid overtime compensation, then odds are that the worker is not being paid for any earned overtime. The Wage & Hour Division has the power to investigate such a case and to require the employer to pay not only earned and unpaid overtime, but also a penalty equal to the earned and unpaid overtime. (Employees also have a private right of action where the Department of Labor fails to act, and prevailing employees are eligible to have their attorney’s fees and litigation expenses paid by the employer.) Because misclassification is a common mistake by employers, the Wage & Hour Division closely monitors for compliance. Any misclassification is unlikely to escape the Wage & Hour Division’s notice for long!
Because misclassification of an employee as an independent contractor will result in the employer failing to remit the appropriate taxes, this misclassification impacts governmental coffers. This means that the IRS regularly monitors for misclassification situations and fines employers that are caught misclassifying their personnel. It is often less expensive in the long run to correct any misclassification before the IRS discovers it. The IRS is currently offering employers an opportunity to voluntarily reclassify workers and avoid some of the penalties that typically flow from the IRS “catching” an employer in a misclassification. Information on the voluntary classification settlement program is available at the IRS website at http://www.irs.gov/irb/2011-41_IRB/ar14.html.
The determination whether a worker should be classified as an employee or an independent contractor is fact specific and should be made with the assistance of counsel. Please contact The Myer Law Firm for guidance on whether workers are properly classified as employees or independent contractors.
Counsel should always be consulted for advice regarding a specific situation. The analysis set forth in this article is provided for general understanding only and should not be considered legal advice. Although this article makes reference to an IRS program, this article should not be considered tax advice. The Myer Law Firm does not offer tax advice.
