Worker Misclassification Dangers of Contract Staffing

The IRS is cracking down on companies who are paying employees as independent contractors without withholding and paying taxes. If the IRS finds a company that has been incorrectly classifying employees as independent contractors, the fine will include the back taxes, penalties, and interest.

The reason companies are tempted to misclassify employees as independent contractors is to avoid several costly and time consuming requirements, including:

  • federal and state tax withholdings
  • deposits and reports
  • the employer’s share of Social Security and Medicare taxes
  • state and federal unemployment insurance premiums
  • state disability insurance premiums
  • Workers’ Compensation costs
  • fringe benefits
  • vicarious liability for employee negligence
  • and EEOC regulations.

Employees are not only expensive but also subject a company to many laws. Employees are covered under:

  • Fair Labor Standards Act
  • Civil Rights Act
  • Age Discrimination Act
  • Americans with Disabilities Act
  • Immigration and Naturalization laws
  • Family Medical Leave Act

For employees, benefits must be provided without discrimination, including Workers’ Compensation coverage, disability insurance, unemployment insurance, vacation accruals, holidays, sick leave, profit sharing, and bonus plan participation.

The extent of the abuse of using independent contractors instead of employees is staggering. The IRS believes that misclassified employees have cost the government billions of dollars in revenue. Nationally known companies have recently been put in the spotlight for worker misclassification. You may have seen some of these cases in the news lately!

Worker Misclassification Penalties

To recoup these losses, the IRS has made finding misclassified employees a high priority in its enforcement efforts.

When the IRS finds a questionable situation, they utilize three major categories – behavioral control, financial control, and the type of relationship, to help determine worker status. The current IRS guidance can be found in Publication 15-A, Employer’s Supplemental Tax Guide – Supplement to Circular E. The distinction between employees and independent contractors can be blurry.

In a dispute over employee classification, the burden of proof is on the employer, not the IRS. This is a very difficult burden to overcome. If misclassification is determined, the company will be liable for federal and state tax, both the employer’s and employee’s share of Social Security and Medicare, state unemployment insurance, plus interest and penalties.

Click here to see the Internal Revenue Service’s official stance regarding worker misclassification.

Click here for a two-page infographic that spells out the IRS guidelines regarding worker misclassification.

The state Workers’ Compensation department will also issue its own fines. An IRS audit usually leads to piggyback state actions, by law in most states. The opposite is also true, when a state conducts an audit, they notify the IRS. Agreements between employees and companies to treat the employees as independent contractors are not valid. Federal and state laws supersede any such agreements.