If you aren't certain your workers are properly classified as employees or independent contractors, you're not alone. Unfortunately, the Department of Labor is keeping an eye out for companies that classify workers as contractors when they are legally employees. This is because contractors aren't entitled to employer contributions to payroll taxes, provide workers' comp, unemployment insurance and other benefits. They are also exempt from a number of protective workplace laws.
If you are found to have misclassified workers, you could owe back wages and overtime. If the DOL decides you misclassified them willfully or intentionally, you could be liable for twice the actual wages owed.
There is another agency with interest in the question: The IRS. This is because misclassification can result in nonpayment or underpayment of federal income and FICA taxes, along with other issues such as noncompliance with the Affordable Care Act and failure to provide W-2 forms. Misclassified workers could mean taxes owed plus penalties and interest.
How does the IRS determine proper worker classification?
The IRS has a legal framework for determining whether a worker is technically an employee or an independent contractor. Although it is not identical to the framework used by the DOL, its principles are the same and it should get the same result. The IRS weighs the factors and determines proper classification based on the totality of the circumstances.
The main idea is control and independence. Workers are more likely to be classified as employees when the company exercises significant control over the details of their work. They are more likely to be classified as independent contractors when they exercise substantial independence. There are three categories of inquiry:
Behavioral: How much control does the company exercise over what the worker does and how they do it?
Financial: Does the company control the financial and business aspects of the worker's job, such as when they are paid and what expenses are reimbursed. Does the company pay for the tools and supplies needed?
Type of relationship: Is this an ongoing working relationship or a one-time project? Does the work represent a key aspect of the company's business? Does the worker receive benefits?
An experienced employment law attorney can help you assess and weigh these factors.
Hiring many contractors? Consider getting an IRS determination
The IRS does offer companies (or workers) the chance to ask for an official determination of proper classification by filing a Form SS-8. Unfortunately, these determinations take at least six months. If your business is hiring a large number of the same types of workers, however, filing an SS-8 form could be efficient and protect you from future misclassification claims.