What Happens When An Employee is Misclassified?

Note: This article was last updated in 2016. Some information may be outdated.

An independent contractor is person, business, or corporation that provides services or goods to another entity under specific terms or contractors. Generally, independent contractors hold control on when and where the agreed upon work will be finished.

Hiring an independent contractor versus a traditional employee means avoiding paying overtime, workers’ compensation insurance, holiday pay, and more. But misclassifying an employee simply to avoid paying these taxes is a huge no-no. Unfortunately, that doesn’t stop some employers from doing just that: An estimated 3.4 million employees are currently considered independent contractors when they really should be employees.

How is this issue caught? Most often a misclassified worker is the one who alerts either his or her state Department of Labor or the U.S. Department of Labor (DOL). From there, the case can be handled at the individual level or an investigation is open, looking into all employees and independent contractors for a three-year period at the offending company.

Consequences are determined if the misclassification was intentional or unintentional. If truly a mistake, the employer faces the following penalties:

• A $50 fine for each W-2 not filed
• 1.5% of that misclassified employee’s wages, plus 40% of FICA from the employees’ wages, and 100% of FICA employer taxes. (With interest, too).
• A 'Failure to Pay Taxes' fine equal to 0.5% of the unpaid tax liability for each month that employee was working, up to 25% of the total tax liability.

Now, if the misclassification was INTENTIONAL, the employer faces the above penalties plus the following:

• 20% of that misclassified employee’s wage, plus 100% of both the employee and employer share of FICA
• Criminal fines of up to $1,000 per employee
• Up to one year in jail
• Personal tax liability for the person who actually misclassified that employee on payroll

Clearly, misclassification of employees is not a joke. Be sure you’re correctly classifying any and all employees to avoid fines and potential jail time!