How to Handle Misclassification of Workers

The misclassification of workers as independent contractors is an issue that federal and state governments have been trying to address for decades. As businesses try to lean out their operations and outsource work to independent contractors, this has become an even greyer area in terms of wage and tax issues. In addition, because the worker classification rules can be very complex, many employers can violate them without even realizing that a mistake was made. There has been a significant increase in the number of employers who classify employees as independent contractors. In light of this, state and federal government agencies regularly perform audits regarding worker classification. If your business has a relatively high number of 1099-MISC forms being filed around tax season, you may be at a higher risk of being audited for worker classification. Even if the audit is performed by only a state agency, there is still a strong possibility that the findings from the state audit will be forwarded to the federal government, which could trigger an additional or supplemental investigation.

Some of the potential liabilities and claims that an employer can face as a result of misclassification of an employee as an independent contractor include payroll taxes, income tax withholding, unemployment insurance, worker’s compensation, and employee benefits. The consequences of having to address the misclassification of a worker can be costly and time-consuming. It is never a good idea to attempt to classify a worker as an independent contractor in hopes of avoiding these costs.

The IRS has recognized that many of the rules related to worker classification can be complex. In order to encourage employers to be more proactive in correcting issues with worker misclassification, the IRS has adopted the Voluntary Classification Settlement Program (VCSP). This program allows employers an opportunity to reclassify independent contractors as employees for the purpose of paying employment taxes for those workers in future pay periods and receive partial relief from paying federal employment taxes. This program is very similar to the Classification Settlement Program, which is available to employers who are already under audit or investigation for the misclassification of workers.

The modified version of the VCSP from IRS Announcement 2012-45 requires that employers have filed all required Forms 1099 for their independent contractors for at least the previous three years and not currently be under audit from the IRS or a state DOL agency. In exchange for agreeing to prospectively treat the class of workers currently classified as independent contractors as employees for future tax periods, the employer will only have to pay 10 percent of the employment tax liability, not be liable for interest or penalties on the unpaid employment tax, and not be subject to an employment tax audit regarding that classification. Before deciding whether this is an appropriate action to take for your business, you should consult with an experienced attorney.

To make sure that your company is complying with state and federal requirements for the classification of employees and workers, contact Simms Showers LLP for a consultation.