Employers Misclassifying Independent Contractors

Government Agencies Cracking Down on Employers Hiring Independent Contractors

Once appealing to hire independent contractors, this label could now place employers in serious trouble with the law.

Government attention has recently focused on employers that hire workers under contractor status. Termed “The Misclassification Initiative,” the government’s investigation of independent contractor hiring practices began ramping up in 2011.

Independent contractors are paid by the jobs they complete and must bear the full burden of self-employment taxes, without any of the benefits. Concerns lie in the fact that when businesses hire workers under this label, contractors are stripped of the rights that traditional employees have, including the ability to file for unemployment, as well as being able to participate in medical insurance and savings plans that are typically offered to traditional W-2 employees. This results in millions of dollars in lost government revenue due to uncollected Medicare and social security, as well as unemployment insurance taxes and payroll taxes – key reasons for the crack down.

In 2001, the Department of Labor (DOL) and the Internal Revenue Service (IRS) created a “memorandum of understanding,” which is presently being used to pinpoint employers that “misclassify” certain employees as independent contractors, when in reality they are not.

Instances of this type of misclassification have spiked in recent years, likely due to both the popularity of using contractors combined with the increasing government scrutiny of the practice. Employers that hire such contractors should be aware of the criteria the DOL and IRS are using, which include:

    • Whether a contractor has investments in the equipment required;
    • Whether a contractor can make a profit or loss in the endeavor;
    • Whether the employer has behavioral or financial control over the worker;
    • Whether the employment is a short and defined duration – or is open-ended.

Businesses that misclassify workers are guilty of skirting labor laws like overtime, minimum wage and beginning in 2014, health-care provision requirements. Some of the punishments of contractor misclassification include fines, penalties and the payment of back taxes, which the employer would have been liable for.

Since it’s anticipated that the crackdown will continue, business owners must understand the criteria for defining independent contractor relationships as well as the potential penalties for the misclassification of worker status. It’s advisable to re-evaluate contractor status in the near future to prevent the potential for thousands of dollars in penalties, fines and back taxes. Links to easy tools provided by the IRS to evaluate contractor relationships can be found in our original blog post on Independent Contractor Misclassification.

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