Businesses who hire independent contractors avoid extra costs associated with employees: payroll tax and liability insurance, compliance with labor and employee benefit regulations, etc. Hiring workers as an independent contractor may seem like an easy option, and many business owners can properly make this classification. However, you could have many reasons to worry if independent contractors are reclassified as employees.
A written independent contractor agreement is not enough if someone is actually an employee under the law. Many parties with a variety of reasons can challenge a worker’s status. Here are some of the potential liabilities your business could incur if an independent contractor is reclassified as an employee:
• IRS – This is at the top of the list. A retroactive recharacterization will turn “contractor fees” into “employee wages”. This means you didn’t withhold income, Social Security and Medicare taxes from wages, or remit them to the IRS on the employee’s behalf. You also didn’t pay the employer’s share of payroll tax and federal unemployment tax to the IRS. Plus, you also didn’t report the employee’s information to the IRS on Forms 941 for quarterly payroll tax or 940 federal unemployment tax. If the IRS determines the employer deliberately misclassified employees as independent contractors, it can make you responsible for all employment taxes that should have been paid, i.e. employer’s share plus employee’s share for income tax and payroll tax. The liability for penalties & interest can also be enormous.
• State Payroll Taxes – This liability will be similar to the IRS, but state payroll and unemployment tax payment & reporting are involved.
• Benefits – Misclassified independent contractors may have to be provided all the same benefits received by your other employees on a non-discriminatory basis. Common benefits are overtime, vacation pay, sick pay, medical and life insurance.
• Pension Plans – A worker that should have been included in an employer’s pension plan may be entitled to retroactive coverage, vesting and contributions. This may necessitate funding changes for the correct amount required. The employer may face disqualification of the plan for improper funding.
• Workmen’s Compensation – Workmen’s compensation insurance provides no-fault coverage to “employees” injured on the job. Independent contractors aren’t entitled to workmen’s compensation. Cases have occurred where independent contractors who were injured on the job have challenged their employment status — and won. The business then becomes liable since the recharacterized worker’s injuries occurred while at work.
• Other litigation – The independent contractor vs. employee issue may be the turning point in how a lawsuit is settled. For example, a business is not liable for an auto accident caused by an independent contractor while working on the job. But if that contractor is proven to really be an employee, the company can become liable for the accident.
The federal government is working on new regulations that would require companies to write an analysis for all worker classes, employees and independent contractors alike. Another proposal would require companies to issue a written document to independent contractors that state which labor and employment law protections don’t apply to the contractor, federal tax obligations, and the worker’s right to ask the IRS to determine if they are an employee or independent contractor.
Hiring an independent contractor can be a valid option for many business owners. Call Gary Kaplan about independent contractor issues covered in this blog. Gary has the knowledge and experience that comes from working with business owners of small and large companies for over 15 years.
