Dangers of misclassifying workers

Are all the workers at your organization properly classified? If not, it could cost you.

4 minutes

On a factory floor, an individual in coveralls and a hardhat, leans over a work table with a tablet in their hand

The challenge of properly classifying workers is drawing increased attention as of late, as both state and federal agencies have been more focused on enforcement. Worker classification has also made headlines due to the Affordable Care Act, which imposed penalties against companies that don’t provide quality and affordable coverage to their employees.

Specifically, the law mandates that a company with at least 50 full-time employees offer coverage to at least 95 percent of them. The 50-employee cut-off has smaller companies closely assessing how they currently classify employees, while also influencing decisions on whether to add either employees or independent contractors to the payroll.

Potential advantages of independent contractors

No doubt, there are some financial incentives for organizations to classify employees as independent contractors – a fact that can put a company at risk for misclassifying if sound policies and best practices are not in place to govern classification.

Specifically, the potential financial advantages for a company to hire independent contractors over employers, include:

  • Independent contractors are reported to the IRS on a Form 1099 instead of a form W-2.
  • Employers are not required to withhold taxes, make Medicare or Social Security contributions, or pay unemployment and worker’s comp premiums for independent contractors.
  • Employee benefit plans, including group health insurance, paid leave, and 401(k) plans, only cover employees and do not typically extend to independent contractors.

Unfortunately, any financial advantages gained can be wiped away due to employee misclassification. That's why it is so important that you take preventative steps to avoid hefty fines, penalties, and potential reputation issues related to non-compliance.

Risky business

The risks of worker misclassification are considerable, as companies are subject to fines and back taxes. On both the federal and state levels, fines can be as much as 100 percent of the employment tax due, depending on the level of culpability. In addition, companies can also be liable for all federal income tax not withheld, all Social Security taxes not withheld, and unemployment tax insurance of 6.2 percent.

The regulations that govern classifying workers contain many “gray areas.” Consider partnering with a tax professional – either on-staff or contracted – who stays current on compliance issues regarding worker classification. 

Employee misclassification best practices

Companies should establish a process for assessing classification status, not only when a worker starts a job but also on a regular basis to make sure their role has not changed. Some other best practices for companies include:

  • Developing enterprise-wide 1099 policy to be followed by internal resources and staffing suppliers.
  • Requiring all suppliers to complete a 20-point IRS checklist on each 1099, and provide documentation prior to start.
  • Not having independent contractors do the exact same work as employees.
  • Requiring all staffing suppliers and all 1099 contractors to provide current insurance policies. Uninsured contractors should be prohibited.
  • Requiring all independent contractors to sign documentation stating they are not entitled to, and will not seek, unemployment benefits.

It’s also good practice to establish a standard “start-of-work” meeting that covers what the independent contractor needs to accomplish. Make certain that the contractor does not receive anything that resembles a job description, but rather a detailed list of specific work and deliverables that need to be completed.

Creating standards and practices to avoid worker misclassification

Justin A. Meyer, an attorney with Meyer and Associates in Hauppauge, New York, emphasized that companies need to establish and adhere to standardized policies regarding worker classification and make sure documentation is kept current. “Employers who work with independent contractors need to be prepared for an audit and ensure that they have the documentation in place to support their positions,” Meyer said.

Adecco helps companies mitigate the risks of employee misclassification by taking ownership of the process. We also provide comprehensive payrolling solutions to take the burden off of you. To learn more, contact us today.