Independent Contractors: Costly If Misclassified
Published October 2010
During times of economic downturn, many businesses increase their use of Independent Contractors (IC) to complete work and avoid the extra cost of an official employee. By hiring an IC, the business can avoid having to match federal and state withholding for taxes, Social Security and Medicare, unemployment benefits and any additional benefits that would be provided for an employee. In addition, the business can hire or fire the IC at will without worrying about any potential discrimination claims and does not have to cover the IC for work-related injuries.
All of these advantages that IC offer help to keep businesses competitive. The big downfall for IC is that misclassification of an IC when they are actually an employee can be very costly. When a business uses ICs there is a loss of revenue to government bodies, both federal and state. Keep in mind that the government agencies deciding who is an employee or IC are the same government agencies who stand to gain financially from making someone an employee. In 2009, the IRS instituted an enforcement program to audit up to 6,000 employers over three years on the issue of classification of IC. Keep in mind that the government agencies deciding who is an employee or IC are the same government agencies who stand to gain financially from making someone an employee.
Given these facts, it is important to have all employees and IC properly classified as such to avoid additional wages that should be paid, back taxes and tax penalties. The IRS can impose large fines, bring criminal charges and also require full payment for failure to withhold taxes even if the IC has already paid their share.
There is nothing that will guarantee that someone you classify as an IC will be considered one by the investigating agency. When employee and IC classification is being investigated, the government agency will look at the circumstances of classifications and impose the “economic realities test” to make their decision. The economic realities test means that written agreements between the business and IC are meaningless along with titles, job descriptions and organization charts. The IRS has developed a “twenty factor test” to determine whether someone should be classified as an employee or IC. The twenty factors are too lengthy to cover in this article, but Lawrence Donoghue will summarize the main ideas behind the twenty factors in the “Independent Contractors: Are They or Aren’t They?” Webinar.