John had been working as a freelance contractor for one company for the past three years. He was promised a fixed rate of pay and was told he would be considered an independent contractor.
John had no benefits, no vacation time, and no job security. He was expected to take care of all of his taxes and other expenses associated with the job.
After three years, he was called into the HR office and told that the company had been conducting an audit and that going forward, he would no longer be considered an independent contractor and would instead be reclassified as an employee.
He was now eligible for vacation time, insurance and other benefits. He also was entitled to get back pay for overtime and benefits that he had been entitled to for the last 3 years. Plus, the company had to pay thousands in penalties to the IRS for the misclassification.
Most people know that W-2 employees must have taxes deducted from their pay, and that the business must remit a variety of taxes on behalf of such employees. However, an independent contractor is paid without any deductions for taxes.
It’s tempting to classify workers as independent contractors to avoid paying the employer’s portion of taxes and eliminate the paperwork of tracking employment taxes.
But it’s important to make sure that independent contracts are not REALLY employees. That is not something that the company or the worker can just decide, and it doesn’t matter how you name the agreement. It depends only on the facts of the relationship.
The fact-specific evaluation should be made with the assistance of counsel because misclassifying workers can lead to fines for violating both tax laws and wage and hour laws.
If you’re unsure whether to hire employees or use contractors, ask yourself: do you enjoy talking to IRS agents?
Avoid or correct misclassification before the IRS discovers it.