Classifying Employees Correctly

Businesses sometimes misclassify individuals as contractors to avoid payroll taxes, unemployment insurance or workers' compensation premiums. But if the IRS, the Department of Labor or a state agency finds misclassification, you may be liable for:

Back payment of the employer share of Social Security and Medicare taxes
Unpaid unemployment and workers' compensation premiums
Overtime and minimum wage back pay
Penalties, interest and legal fees

The savings you thought you gained can quickly disappear, and the audit trail may extend back several years.

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Myths that get employers in trouble

Many employers mistakenly believe that sending a 1099 form automatically classifies someone as a contractor. It doesn't. Others think that a signed "independent contractor agreement" guarantees contractor status. This is also incorrect. Some employers assume that if a worker isn't on the official payroll, perhaps they are paid in cash or kept "off the books", they do not count as an employee. This assumption is also wrong. Agencies look at the actual work relationship rather than just the paperwork.

The real tests concern control and dependence: Do you direct how the work is done? Is the worker economically dependent on your business? Is the work integral to your business? These factors strongly indicate that the individual should be classified as an employee. This holds true even if they have a limited liability company, work off-site or have been called a contractor in the past.

State laws may impose even stricter classification standards, using different or additional tests. Further, in many states, a worker you designate as a contractor may still qualify for unemployment benefits.

The bottom line

Independent contractors are genuinely independent; they operate their own businesses. If you control how, when and where someone works and if the work is integral to your business, these are strong signs that the worker should be classified as an employee. However, no single factor determines the outcome; agencies evaluate the entire context of the relationship to assess status. Misclassifying workers can result in back wages and taxes as well as invite lawsuits and enforcement actions that can harm your reputation. Proper classification ensures compliance, maintains competitiveness and helps you avoid legal issues.

Interested in learning more? Chat with a Connectify HR expert today.

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