Continuing its efforts to combat worker misclassification, the Department of Labor (DOL) recently announced it is awarding more than $10 million to help states beef up misclassification detection and enforcement initiatives in unemployment insurance programs. The grants will bolster the ability of 19 states’ unemployment insurance tax programs to audit employers suspected of misclassifying workers as independent contractors or failing to report paid wages. The money will also fund employer education programs.
As the DOL and Internal Revenue Service continue to invest in misclassification enforcement, business owners need to understand the difference between independent contractors and employees. Small and medium-sized businesses may be particularly vulnerable on this issue, as these companies may rely heavily on freelancers or outsourced labor.
Independent Contract vs. Employee
Independent contractors are typically issued a 1099-MISC at the end of the year and are responsible for paying their own taxes. Having employees, by contrast, requires a company to withhold income taxes, pay FICA and FUTA taxes, provide workers’ compensation insurance, and more. Properly classifying a worker as an independent contractor may save an employer money in areas including health benefits, unemployment insurance contributions, and social security withholdings.
The Consequences of Misclassification
Improperly classifying a worker as an independent contractor means employers do not pay their share of payroll taxes, which shortchanges the employee as well as the IRS. Misclassifying workers can carry heavy penalties, including fines, having to pay back payroll taxes and workers’ compensation insurance, and more.
How to Know the Difference
To determine whether a worker is an independent contractor or an employee, an employer may take a number of factors into consideration. These factors include, but are not limited to:
- How much freedom the worker has in how they complete a project
- How essential their work is to the company's survival
- Whether they are able to work for other clients
- The permanency of the relationship
- Whether they use their own tools and equipment
These criteria are just a guideline; to determine whether a worker has been misclassified, the relationship between the worker and the employer is typically evaluated as a whole.
If an employer is unsure whether their worker should be classified as an employee or an independent contractor, it’s best to be safe and consult an expert, rather than risk a misclassification penalty. Human resource professionals and legal counsel are both valuable resources in the classification process.