Classifying Employees vs. Independent Contractors: Part 1

Classifying Employees vs. Independent Contractors: Part 1

Every year, US employers in South Florida and other states improperly classify their contract workers during year-end tax reporting. This is a mistake that’s costing the US tax payers and the government nearly $1.2 million in lost tax revenues. According to the most recent figures from the inspector general, this equates to nearly 20 percent of all US employers who issue 1099s instead of W2s because they fail to check IRS compliance when processing payroll taxes at year-end. It’s a growing problem that your business can be held liable for in a court of law.

The Cost of Misclassifying Workers During Payroll Processing

Some organizations have found out the hard way what can happen if they fail to classify their workers the right way:

  • The US Department of Labor disciplined three construction companies to pay $491,000 in back pay and another $108, 900 was ordered in civil fines for misclassifying workers.
  • The Orange County, California Register settled a lawsuit after five-years in court to the tune of $22 million because they misclassified workers as 1099 independent contractors.
  • The IRS ordered a well-known shipping company to pay almost $350 million in back taxes and penalties for failing to classify workers as employees.

Why is Worker Misclassification a Problem?

It seems this problem corresponds with the increase use of contract workforces due to economic hardships faced by many industries, coupled with shortages in specialized skillsets in the labor market. It’s also a growing problem in South Florida where companies are tempted to treat their employees as independent contractors due to the financial burdens of Obamacare. Some companies may try to get around the high costs of providing overtime pay and health care benefits by working with a certain number of independent contractors (ICs) instead. Very often, a company considers a worker to be an IC, but in reality the nature of the work performed falls under employee status.

Use these Guidelines when Classifying 1099 Independent Contractors

  • ICs are not entitled to minimum wage, payment for breaks, or overtime pay.
  • ICs choose to work when they want and where they want, using their own equipment to perform work.
  • ICs cannot receive unemployment benefits.
  • ICs are generally paid by the project, not by the hour.

When Classifying Your Employee W2 Status Workers, Use these General Guidelines

  • Employees are required to work a specific schedule or number of hours per week, and payment is by the hour.
  • Employees are eligible for minimum wage, overtime, unemployment insurance, and disability insurance.
  • Employees are required to use the company property and tools to perform tasks.
  • Employees can be restricted from working for other organizations or competitors.

It’s a known fact that the IRS and state workforce agencies will red-flag any organization that classifies workers as both W2 and 1099 independent contractors in a single tax year. While it can occur occasionally, such as when an employee decides to terminate the employee relationship and become an independent contractor or vice versa, this is actually a rare case. Use caution before issuing W2s or 1099s at the end of the tax year by checking current IRS rules on classifying employment taxes for your contract workforce.

Click here to read part 2 of Classifying Employees – the IRS 20 Factor Rule

SourceOne Partners is comprised of an experienced team of payroll professionals that can help you find a payroll company that fits your specific needs. With offices in South Florida and New Jersey, we can help you find a solution to better manage your payroll services, employee benefits and company taxes so that you can save time, money and avoid the penalties of non-compliance. Please call 561-674-0748 to speak with a payroll expert or click here to contact us online.