Employee classification is one of the most convoluted aspects of U.S. labor laws. As such, it is estimated that employee misclassification costs the government billions of dollars in revenue every year. The government began more aggressive enforcement efforts in 2011 with the establishment of the Employee Misclassification Initiative.
BenefitMall, a nationwide payroll and benefits provider based in Dallas, says that it is imperative for employers to fully understand IRS guidelines for classifying employees. In conjunction with the Department of Labor, they have undertaken an extensive education effort designed to bring employers into greater compliance.
As an employer, there are five things you need to know about classifying your workers as contractors:
1. Issuing a 1099 Does Not Establish Contractor Status
BenefitMall frequently deals with new clients that have previously assumed issuing 1099s to some workers automatically made them contractors. The 1099 forms does no such thing. Independent contractors are classified as such based on certain criteria applied to the work they do. A 1099 form is simply a means of reporting income paid to correctly classified contractors.
Furthermore, an employee can be considered an independent contractor for tax purposes but still an employee under the FLSA. The FLSA designation would make an employee eligible for certain benefits, like overtime pay, for example.
2. Contractors May Still Be Eligible for Unemployment Insurance
Unemployment insurance (UI) is the domain of states rather than the federal government. Therefore, employers must check with state officials to determine whether their contractors are eligible for UI. If there is a question, it is better to err on the side of caution until clarification can be provided.
3. Workers Not on the Payroll May Still Be Employees
Another misconception among employers is that workers not officially on the payroll are automatically self-employed contractors. Again, this is not necessarily the case. Employee classification is determined largely by whether a worker’s daily tasks are within the legal definition of employment. Paying legal employees off the payroll could be construed by the IRS and state taxing authorities as an attempt to pay them ‘under the table’.
4. Franchising Is a Very Gray Area
Franchisees are typically classified as independent business owners paying for the right to be affiliated to the franchise operator. But there are times when franchisees are still considered employees. For example, if a franchisee is economically dependent on the operator for employment, that franchisee is probably an employee for tax purposes.
5. Common Industry Practice Is Not a Standard
Lastly, common industry practice is not a standard that can be relied on for employee classification. One need only look at the ongoing cases involving the trucking industry in California. Some industries have a long-standing practice of making extensive use of contractors without ever considering the legal definition of the work those contractors do.
As a general rule, companies that believe their workers are independent contractors based on years of industry practice should take a step back and review what they are doing in light of the actual law. As the trucking industry is finding out, ignoring employment classification can wind up costing companies years of back wages along with punitive damages.
BenefitMall says that outsourcing payroll to a third-party provider does not guarantee 100% compliance with employee classification rules. However, it does greatly reduce the risks. Payroll service providers make it their business to know the law, understand it, and know how to apply it to client circumstances. Any company struggling with employee classification problems would do well to seek the help of the payroll services provider.