In September of 2015, the Hawaii Department of Labor and Industrial Relations (DLIR) signed a three-year agreement with its federal counterpart to ramp up efforts to protect workers from being incorrectly hired as independent contractors instead of employees.
This alliance includes joint investigations by local and federal government authorities and increased educational outreach. In light of this, Hawaii businesses would do well to ensure that they are correctly classifying their workers or face potential legal consequences.
Contractor vs. employee—which is which?
Understanding the difference between an employee and an independent contractor can be difficult to decipher. Even the IRS notes that, “there is no magic or a set number of factors that makes the worker an employee or an independent contractor,” and that, “factors which are relevant in one situation may not be relevant in another.”
Considerations for classification determination
Still, the IRS helps relieve confusion on the topic by providing three categories that must be considered when making a classification determination:
- Behavioral control. Does the employer have the right to direct and control the worker? Do they specify how, when, or where to do the work, or provide the tools and equipment to do the work? If so, the worker should likely be classified and paid as an employee.
- Financial control. If the worker has a significant investment in the job or if he/she is reimbursed for some or all businesses expenses, the individual is likely an independent contractor. Additionally, if the worker can realize a profit or incur a loss, this also suggests that he/she may be an independent contractor.
- Type of relationship. A worker that receives benefits, such as insurance or paid leave, and who is considered a key aspect of the regular business of the company, is probably an employee.
The IRS instructs employers to look at the entire relationship, consider the degree of control, and to use each of these factors when coming up with the classification determination. For more information on how to differentiate between an employee and independent contractor, the IRS suggests referring to Publication 15-A.
What are the consequences of misclassifying employees?
A company that has unintentionally classified an employee as an independent contractor, may be held liable for employment taxes for the worker and will likely be faced with at least the following penalties:
- $50 for each Form W-2 that the employer failed to file.
- Penalties equal to 1.5% of the employee’s wages, plus 40% of the FICA taxes that were not withheld from the employee and 100% of the matching FICA taxes the employer should have paid. Interest is also accrued on these penalties daily from the date they should have been deposited.
- A Failure to Pay penalty equal to 0.5% of the unpaid tax liability for each month up to 25% of the total tax liability.
Additionally, keep in mind that a business that misclassifies workers opens itself up to third-party and class-action lawsuits. And if the IRS suspects that the business is guilty of intentional misclassification or fraud, it can impose additional fines and penalties.
Steps to protect your business
Your company should aim to ensure that every new hire and current worker is properly classified. Consider specifying the working relationship between your company and the worker in the job offer letter and make sure it applies. At the same time, understand that simply having a worker sign an agreement that states he/she is not an employee does not necessarily make it so.
If your company or the new worker has questions about classification, you can request that the IRS evaluate the relationship and make the determination by filing Form SS-8, however, this can take at least six months to process. During that waiting period, a best practice is to treat the worker as an employee in order to avoid any potential penalties.
To learn more about correctly classifying your workers, visit the IRS webpage. Be sure to also check with your HR representative as certain state laws and regulations also apply. Additionally, ALTRES has published an informational flyer on the subject that can be referenced as you set out to classify your workers. View and download the flyer here.
This article is for informational purposes only and does not constitute legal advice. Readers should first consult their attorney, accountant or adviser before acting upon any information in this article.