This week’s question: MISCLASSIFICATION OF EMPLOYEES AS INDEPENDENT CONTRACTORS?
QUESTION: I own a small company that does projects on contract. The projects last from six months to a couple of years. I hire people as “independent contractors” on these projects. They work full-time, on-site, but only while a specific project is active. An acquaintance told me the workers aren’t really “independent contractors” even though they only work for me short-term, and I could get into trouble. Is he right?
ANSWER: Unfortunately, it sounds like the answer is yes. Depending on the facts of your case, you could be in a lot of trouble.
It’s easy to be tempted to call a worker an “independent contractor” instead of an “employee”. Employers aren’t responsible for paying Social Security or Medicare taxed or unemployment insurance for independent contractors. Employers don’t have to give independent contractors overtime, holiday pay, leave, or provide health benefits. While the savings are great for an employer, misclassification costs the government billions of dollars in lost income. And you don’t want to mess with the IRS.
Misclassifying employees is a serious matter, with some serious penalties. An employer must pay penalties of 1.5% of the wages, plus 40% of the Social Security and Medicare taxes that were not withheld from the employee, and 100% of the Social Security and Medicare taxes the employer should have paid, plus daily interest on these penalties. In cases of suspected fraud or intentional misconduct, the IRS may impose additional fines and penalties and may seek criminal punishment, with fines of up to $1,000 per misclassified worker and/or a year in prison. Back taxes and penalties can add up to the hundreds of thousands of dollars.
So, how can you avoid misclassifying workers? According to recent guidelines issued by the Department of Labor (DOL), an “economic reality test” should be used should be used when determining if a worker is an independent contractor – someone who is in business for himself or herself, who is not economically dependent on the business he or she serves – or an employee. The DOL looks at seven factors in making this distinction:
The extent to which the services rendered are an integral part of the principal’s business. For example, if you are in the business of construction, the services of a carpenter are integral to your business. However, the services of a software designer who creates a program for you to better handle billing, would not be integral to your business.
The permanency of the relationship.
The amount of the alleged contractor’s investment in facilities and equipment. How much skin does the worker have in the game? Does he or she provide equipment or resources other than his or her labor?
The nature and degree of control by the principal. Who sets the schedule, dress code, lunch breaks, work requirements? What bargaining power does the worker have?
The alleged contractor’s opportunities for profit and loss.
The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
The degree of independent business organization and operation.
You indicate that you have a short-term work relationship with the workers you hire, one of the few factors in favor of finding an independent contractor relationship, but also that they work full-time, on-site, which would indicate that they are likely employees. It also appears from your question that you may have misclassified your employees innocently, without intent to defraud.
If you are investigated by the IRS or the DOL, experienced employment attorneys – like those at Gwinn Tauriainen PLLC — can help you present your case more favorably, and possibly avoid a government finding of fraud.