Implications of misclassifying workers

Your Guide to State, Local, Federal, Estate + International Taxation

misclassifying workers, IRS, tax, businessWhat type of workers do you have in your business? How do you determine if they are a contractor or an employee? These are questions that need to be asked and thought about on a consistent basis because of the implications that the wrong answers can create. You don’t want to end up misclassifying workers.

If businesses do not properly understand the rules and regulations set forth by the IRS and the Department of Labor (DOL), they could potentially misstate the class of their workers and face some major penalties. The difficult part regarding these issues is that there is no bright-line test to judge whether a worker is an employee or an independent contractor. The IRS does have a 20-factor test that you can follow in order to help you determine the status of your workers. They have broken it down into three main categories:

  • Behavioral control
  • Financial control
  • The relationship of the parties

Misclassifying workers is something that the IRS, DOL and state workers compensation boards are focusing on right now. These departments share information with one another and because of this you can find yourself finishing one audit and getting pulled into another one for the same issues. This can cause a lot of strain on your business and if you lose the audit the implications are drastic. You will be assessed fees for unpaid employee taxes withheld and on top of that, interest and penalties will be calculated for the whole time the employee is deemed to be misclassified. To add fuel to the fire, these fees are assessed per employee deemed to be misclassified. These fees can add up every quickly.

If you are hiring a new worker, talk to your CPA. They can help give you some guidance on how to determine if you have employees or independent contractors. Trust me – the upfront fees from the advice from your CPA could potentially save you hundreds of thousands of dollars in the long run.

Meghan Scott, EA