Our Human Resources Blog

For many businesses, hiring people as independent contractors vs. employees can be a cost effective way of getting the work done. There can be significant savings when using independent contractors, as the laws do not require employers to pay minimum wage, overtime or provide the same level of benefits for these workers. The laws also don't require employers to withhold or pay federal, state and social security taxes for independent contractors. Classifying workers as independent contractors can be a cost saving strategy for businesses, but it can also be exposing them to severe risks and fines.

The IRS claims to loose billions of dollars a year in unpaid taxes from misclassification, with a substantial portion of these losses stemming from underpayments or non-payments by independent workers. These revenue losses have the IRS extremely motivated to make certain that businesses are not misclassifying their employees. The IRS plans to increase their tax audits this fall, with a main focus on worker classifications.  State and local governments are also very active in targeting these misclassifications. At least six states have recently enacted legislation or are considering legislation to halt misclassifications. More states are jumping onboard as they look to generate increased revenues.  In Maryland, The Workplace Fraud Act of 2009 imposes fines of up to $5000 per "misclassified" employee, for a first time offense. (Fines are doubled for a second time offense.)

In addition to imposing penalties, many states are also requiring businesses keep records of employee and independent contractor classifications. They will also be required to notify workers of their classification and their right to challenge it. If employers fail to provide proper documentation when requested, fines of $500 per day can be imposed.

Knowing if employees are correctly classified can be very confusing. There are no hard and fast rules, and every situation is different. As far as the government is concerned there are many different factors that need to be considered. So, how do companies avoid a worker classification audit, get the talent they need and still utilize cost effective ways to run their business? Very good question...

At the end of the day using an independent contractor is a decision only businesses can make. Before making the decision though, a careful analysis of both federal and local classification tests should be done.  It's also important for businesses to keep accurate records and have sufficient documentation. Most importantly, businesses should keep their fingers crossed and hope they have adequately protected themselves from the dangers of a misclassification allegation.