What are the Independent Contractor Misclassification Penalties?

As a small business, have you ever struggled to classify your workers? Hiring decisions are difficult, especially when you’re unsure which type of employment relationship best suits your work. You may be thinking about bringing on an independent contractor if you don’t require full-time support. On the other hand, it might make more sense to add a part-time employee to the payroll than a contractor. It depends on the nature of work, amount of direction, and some other compliance complexities.

Before you decide, know the stipulations of each type. Misclassification of a worker could mean severe fines and penalties. To avoid independent contractor misclassification penalties, understand the differences between each model.

What’s the difference between employees and independent contractors?

One of the most significant differences between employees and independent contractors are payments and taxes. An independent contractor is paid a total amount for their work and held responsible for all tax obligations. Employees, however, receive paychecks with tax withheld. The employer withholds a certain amount from each paycheck before disbursing the employee’s payment.

Employees are also protected by labor laws and eligible for benefits, whereas contractors are not. Beyond the fundamental differences, each state has their own regulations for independent contractors. For example, California’s new “ABC” Contractor Law defines clear terms for the state. Check with your state to ensure compliance at a local level and avoid independent contractor misclassification penalties.

Do independent contractors get paid hourly?

It is common for contract workers to get paid hourly. However, these workers are not typically guaranteed a regular amount of hours each week. Unlike full-time employees, who can expect a standard 40-hour workweek, contractors are only paid for the number of hours they work on each project. Hours can fluctuate each week depending on the company’s needs.

Depending on the client, contractors can also be paid a flat rate fee for work. For example, a company who needs the same amount of support each month may agree to pay the contractor a flat rate (also known as a monthly retainer). This type of pay structure can be easier for accounting purposes, as it eliminates the need for both parties to track weekly hours and manage payroll.

A contract relationship offers more freedom over payment terms compared to employees who are paid a salary or hourly rate.

Is there a minimum wage for independent contractors?

Minimum wage requirements do not apply to independent contractors. However, this doesn’t mean contractors are subject to low paying opportunities. Independent contractors oftentimes set their work rates.

The employer will either agree to the contractor’s rate or negotiate an agreement that’s beneficial for both parties. Contractors do not have to accept paid opportunities that fail to meet their financial requirements. Similarly, companies do not have to work with a contractor if compensation requirements do not meet the company budget.

What are the penalties if I misclassify an independent contractor?

Misclassification can result in the employer paying back taxes, fees, and penalties. Therefore, it’s critical to get it right during the hiring process to avoid putting yourself and your business at risk.

Back Taxes

Back taxes can be owed if an organization misclassifies an employee as an independent contractor. When this happens, the employer is responsible for paying owed federal and state taxes. Hefty back tax payments may be required depending on how long the employee works while misclassified.

Withholding Benefits

If a worker is misclassified as an independent contractor, they could be eligible to receive benefits. If the individual didn’t receive benefits from the start of the working relationship, the employer is accountable for all fees owed.

Lawsuit

Depending on the severity of the misclassification, employers can face a trial. A lawsuit can entail legal costs, damage fees, compensation payments, and more. In addition to financial distress, lawsuits can damage the company’s reputation. Protect your organization from independent contractor misclassification penalties by conducting appropriate research on employer-employee relationships before hiring an individual. 

Do you need additional help? Speak with a Zenefits HR Advisor today.