9 Consequences of Misclassifying Your 1099 Contractors
The classification of 1099 contractors and W-2 employees is always a high-priority topic for organizations looking to continue expanding their use of independent contractors and with good reason.
The cost of non-compliance can be staggering. Fines levied by the US Department of Labor (DOL), IRS, and state agencies for worker misclassification can exceed millions depending on the severity of the infractions. The threat of class action lawsuits should also serve as a further deterrent for companies straddling the boundaries of improper classification.
As more and more companies begin leveraging independent contractors, it's paramount that HR executives and CHROs are armed with all the information they need to mitigate compliance risk and properly classify their workers.
The following is a list of some consequences of misclassifying a worker as an independent contractor. While this isn't an exhaustive list, these risks alone highlight the critical need for companies to take proper steps to ensure their contractors and employees are properly classified.
1. Wage law violations
Employers that hire individuals as independent contractors (who should instead be classified as employees) may be held liable for failure to pay overtime and minimum wage under the federal Fair Labor Standards Act (FLSA) and applicable state wage laws. The statute of limitations for an individual to file a wage claim under the FLSA is two years for a non-willful violation and three years for a willful violation. ("Willful" means the employer knew, suspected, or had reason to know that their actions might violate the FLSA.)
Both criminal penalties and liability for back wages may be levied against employers and executives found in violation of FLSA laws. This is an area of intense focus by the DOL, which has recently hired many new investigators to review wage compliance, which would include ensuring that employers are not improperly classifying workers as independent contractors.
In addition, the potential civil liability exposure for companies that misclassify workers is huge. Employers found in violation may incur massive penalties, including unpaid overtime costs and minimum wage deficits – plus liquidated damages equal to unpaid wages and attorney's fees.
2. Unpaid employment taxes
For workers misclassified as independent contractors, employers may also face penalties for failing to withhold and remit state and federal payroll taxes, including failure to make social security and Medicare tax payments.
3. I-9 violations
Workers who are misclassified as independent contractors could also create employer liability relating to employer verification requirements. Specifically, employers are obligated to keep properly completed Form I-9s on file for each of their employees. An employer could be subject to an audit of its Form I-9 records by the Department of Homeland Security, Immigration and Customs Enforcement (ICE), and the Department of Labor.
Suppose an employer misclassifies an individual as an independent contractor. In that case, they will not have the required Form I-9 on file and could be subject to penalties that include civil fines, criminal penalties, debarment from government contracts, and court orders. Form I-9 audits often target industries where labor might not be closely controlled, such as construction, home healthcare, warehousing, and poultry processing.
4. Unemployment insurance shortfalls
Another potential cost of misclassification may be penalties for failure to pay state unemployment insurance for the individual. The issue typically is whether the Employer's Quarterly Wage List and Employer's Contribution Report submitted by the employer to Workforce Services accurately reports the number of employees, as these are the reports the contribution rate is based upon.
5. Unpaid workers' compensation premiums
Misclassification can also result in penalties for violating state workers' compensation insurance laws and liability for unpaid workers' compensation premiums. Additionally, claims from an individual misclassified as an independent contractor will be the employer's sole responsibility and will not be covered by the employer's workers' compensation insurance policy.
6. Improper exclusion from benefits
Misclassified workers may be entitled to receive or participate in an employer's employee benefits, including pension and other retirement plan coverage, health insurance plan coverage, paid leave allowances, and severance pay, among others. There is often a lot of enforcement and lawsuits relating to failure to provide benefits, so this is an area with potential for substantial liability.
7. Anti-discrimination violations
Misclassification may also result in failure to provide required protections to individuals under state and federal anti-discrimination laws. Those workers improperly classified as independent contractors could be entitled to certain notice obligations and enforcement protections relating to these laws. An employer's violation of any of these rights could result in agency charges of discrimination or lawsuits for failure to provide these required protections.
8. Failure to provide job-protected leave
Suppose an individual should have been classified as an employee. In that case, employers may have certain obligations to provide leave to eligible employees under applicable laws like the federal Family and Medical Leave Act (FMLA) and the Uniformed Services Employment and Reemployment Rights Act (USERRA). Failure to provide protected leave, reinstate individuals that took protected leave, or retaliate against individuals that requested or took protected leave could result in legal claims against an employer.
9. Failure to provide the required notice
Employees are also entitled to notice under many different laws, and failure to correctly classify an individual as an employee could affect the employer's compliance with these laws. For example, failure to count misclassified workers when determining federal WARN Act and state mini-WARN Act compliance obligations in the event of mass layoffs and plant closings, as well as failure to give required WARN notices to affected misclassified workers under these laws, could result in employer fines, back pay, and other penalties for non-compliance.
The bottom line: You can't afford to misclassify
The misclassification of workers significantly impacts the individual worker, the employer, and the economy at large. At the same time, individuals are increasingly seeking roles as independent contractors to control how they engage in work. No single factor determines misclassification, making the complexities of worker status even more arduous to manage. Because of the high potential cost of misclassification and the additional DOL investigators available to challenge your worker classification, it is more important than ever to ensure you correctly classify your workforce.
To learn more about best practices for properly managing your independent contractor workforce, download our "Classification 101" whitepaper.
