There’s no denying the fact that some companies classify their employees incorrectly, often by listing them as freelance workers rather than regular full-time employees (meaning that they receive a 1099 rather than the W-2 form that most people are accustomed to receiving).
There are quite a few consequences to misclassifying employees, and some of them can be quite serious (both for you and your employees) so in order to better help you understand the ramifications of classifying your employees we’re going to discuss the differences between these two classifications and then go over some of the consequences for improper classifications.
Regular Employees versus Independent Contractors: What’s the difference?
Most improper classifications occur when ordinary employees (who work either full-time or part-time for a company) are classified as independent contractors rather than regular employees.
The primary difference between these two classifications comes down to payroll taxes. When you’re an ordinary employee, your payroll taxes are calculated and deducted automatically out of your regular paycheck (and this amount will later be shown on the W-2 you receive from your employer). When you’re an independent contractor, however, you receive a 1099 and are responsible for calculating your own payroll taxes and then keeping your state government apprised as to the specific amount.
In regards to determining who is an employee and who is an independent contractor, the primary question to ask is “who is this person working for?”.
If they are employed directly by your company (for example, if they report directly to someone for assignments, have a set schedule, tools for the work are provided by the company, and so on), then they are probably an employee. Alternatively, if they are someone the company has hired from the outside, such as a freelancer (who has other clients, works according to their own timetable and using their own methods, could turn down assignments or walk away entirely if they felt like it, and has no real boss other than themselves) then they are likely an independent contractor.
In any case, employee misclassification occurs when regular employees are classified are independent contractors or vice versa.
This is sometimes done accidentally, but also sometimes deliberately (generally in an attempt to save money on the company’s part but also for certain tax reasons). Either way, there can be serious consequences for both employee and employer when workers are not properly classified; we have some of these potential consequences listed up next.
Consequences of Not Classifying Employees Properly
There are quite a few serious consequences that can come from misclassifying employees, regardless of whether it happens accidentally or is done deliberately. Some of these potential consequences are as follows:
Your employee has not been paid correctly. Often, an employee who has been incorrectly classified does not receive the pay that they are due (a lack of compensation for overtime, in particular, is a common problem).
Taxes have not been reported correctly. When an employee is misclassified, it causes problems for the employee’s taxes (as well as for your company’s taxes where that employee is concerned).
Appropriate benefits have not been given to the employee. If an employee is misclassified as a contractor, they might miss out on retirement and health insurance benefits that they are entitled to. They might also end up exempt from OSHA safety measures that they should be protected by.
You will have to pay fee and fines for incorrect classifications. The government has very steep fines when it comes to incorrect employee classifications. In fact, according to various sources (including the IRS), an employer can end up paying over forty percent of a worker’s wages in the form of back taxes if they are misclassified. Furthermore, if this improper classification was done deliberately, the company may even face criminal charges.
Ultimately, it’s far preferable to take the time to classify your employees correctly from the start; this will save both your and the employee in question a lot of time and stress.
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