Dangers of Misclassifying Workers


Are all the workers at your organization properly classified as either employees or independent contractors?

That’s a question that business leaders and HR professionals need to consistently ask – and make sure they are getting an accurate answer. It’s critical to know ways your company can “stay safe” when it comes to a range of compliance issues such as classifying workers. The more you know, the better prepared you are to take preventative steps to avoid hefty fines, penalties, and potential reputation issues related to noncompliance.

The issue of misclassifying workers is drawing increased attention as of late, as both state and federal agencies have been more focused on enforcement. Worker classification is also making headlines due to the Affordable Care Act. This health-care law will impose 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

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.

Of course, any financial incentive evaporates swiftly at an organization found to be out of compliance. With enforcement efforts intensified, companies need to be fully aware of the potential risks.

Risky business

And the risks are considerable. Companies found to be misclassifying workers are subject to fines and back taxes. On both the federal and state level, 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.

Stacy Reynolds, a Vice President of Operations at Adecco Professional Staffing who advises on compliance issues, emphasizes that regulations that govern classifying workers contain many “gray areas.” Her overarching recommendation is to partner with a tax professional – either on staff or contracted – who stays current on compliance issues regarding worker classification.

"You really need a tax pro to help make sure you are classifying correctly,” Reynolds says. “Many companies are letting HR make determinations. While they are well-intentioned, that can be a problem because the law is very nuanced."

Best practices

Reynolds suggests that companies also establish a process to assess classification status not only when a worker starts a job but also on a regular basis to make sure their role has not changed in ways that would require reclassification.

Some other best practices for companies include:

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

Be prepared

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 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.

Justin A. Meyer, an attorney with 
Meyer and Associates in Hauppauge, NY, emphasizes 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 says.

At Adecco Transportation & Warehousing, we specialize in connecting employers like you with extraordinary professionals on a temporary or permanent basis. To find out more, contact us today.