Avoid These Employee Misclassification Pitfalls in Your Company

Employee Misclassification quoteOver the past three years, there has been a 30 percent increase in states with worker misclassification laws in place. Currently, thirty states have laws in place, which is up from twenty-three states in 2010.

Employee misclassification is prevalent in the construction industry where workers are often classified as independent contractors. However, the construction industry is not the only culprit. Any company with employees and independent contractors is at risk for misclassification.

Here are several tips to help you understand how to classify subcontractors and employees and to help you avoid an IRS audit for this reason.

Why it’s appealing.

Employers who choose to classify employees as independent contractors, when they are truly employees, can shave quite a bit from their overhead, including benefits, insurance, and wages when considering overtime.

According to the June 14, 2013 “Employers Do Not Always Follow Internal Revenue Services Worker Determination Rulings” report from the Treasury Inspector General for Tax Administration, for each worker making approximately $43,000 in 2012, $3,700 could be saved by the employer annually.

Employee or Independent Contractor

Determining if someone is an employee or independent contractor is pretty clear. Here are three tests to help you make that determination. If you are unsure, download our checklist to help you get started.

  1. Behavioral. Does the company have the control or the right to control what the worker does and how that work is to be performed? For example, an employee is subject to the business’ instruction about when, where, and how to work.
  2. Financial. Are business aspects of the worker’s job controlled by the company? This includes How the worker is paid; whether expenses are reimbursed;and who provides the tools and supplies?
  3. Relationship. Are there written contracts or employee benefits available to the worker, such as pension, insurance, vacation pay, etc.? Will the relationship continue and is the work a key aspect of the business?

If you answered yes to any of these questions, the worker should be classified as an employee. But, before making any changes in an employee’s classification, speak with a qualified CPA who is familiar with the legislation and who can help you answer these questions.

Hot Water

Don’t get into hot water waiting for the IRS to catch on. If the IRS determines an employee has been misclassified as an independent contractor, the worker is responsible for paying only the employee portion of employment tax, while the employer would be responsible for the rest.

Relief for Employers

Employers may find relief in paying employment taxes if their business qualifies under Section 530 of the Revenue Act of 1978, or also known as safe harbor. This Act prevents the IRS from retroactively reclassifying “independent contractors” as employees.

In order to qualify, employers must meet these qualifications:

  • Reporting. All required Federal tax returns for independent contractors must be filed.
  • Consistency. All workers, and any similar workers, must be treated similarly. For example, if workers doing the same job have previously been classified as employees, they would continue to be classified as an employee; and, thus, the relief is not available.
  • Reasonable Basis. If a business received notice previously that workers were independent—from an IRS court case ruling or audit—they would continue to be classified as such.

Need Help

If you are unsure about how to classify workers in your business, Lang Allan & Company can help. We specialize in construction and real estate accounting and business management, and work as an advisor to many businesses with multi-classification employees.

Don’t wait to hear from the IRS that you’ve misclassified employees. Know up front how to do it right. Contact us for more information.

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