MODULE 3: Case Study
Employee misclassification leads to employment lawsuits. The practice is associated with hefty fines and penalties. It is thus important that employers differentiate employees and independent contractors to avoid penalties. In the case study, the major fact is that there is an issue of worker misclassification. Two facts can help the case; unintentional misclassification and worker maliciousness. Ensuring that the worker is an independent contractor and not an employee would have protected the employer. Apart from IRS, DOL at federal and state level, and state agencies would be interested in the misclassification mistake. Without a reasonable basis on why an employee is classified as an independent contractor, then an employee is subjected to hefty fines and penalties.
Important facts about the case
It is a fact that the employer required an independent contractor. It is however clear that there is an issue in employee classification. This is because most of the things included in the contract signal an employee rather than an independent contractor. Some of the facts that serve as red flags are timely salary, employer providing tools, long-term contract, and long working hours. Intentional or unintentional misclassification of workers attract fines and penalties and should be avoided at any cost (Phin, 2014).
Facts that could help the case
The fact that the worker disappeared and left the employer without necessary skills would help the case. If true, the fact can be used to signal the maliciousness of the worker extended in the avoidance of paying the taxes. If it is true that the employer hired the worker on an independent contractor basis, then fact can help the case assuming that IRS finds the mistake unintentional. However, there are several things that the employer could have taken into consideration to avoid IRS penalties (Phin, 2014). First is have a written contract that indicates the terms of the contract. It should indicate that the worker is to use their tools and equipment among other essential details. Second, the employer should have ensured that the worker is not an employee but an independent contractor (Phin, 2014). This will ensure that the worker is correctly classified.
Facts that could hurt the case
If it is true that the employer worked the independent contractor for over 50 hours per week, then the case would be hurt. Working for more than 40 hours per week indicates that she is not working for any other client. In this case, she can only be a fulltime employee. Additionally, if it is true that the employer lacked proper recording and failed to keep track of the actual hours that she worked, then the case will be hurt. IRS expects employees to keep proper recording for a proper audit (IRS, 2018). Second if it is true that the employer provided tools and equipment, then the case would be weakened. Independent contractors own businesses and therefore have their own tools. Giving her credit card to purchase essential tools and equipment will definitely raise eyebrows.
Additionally, if it is true that the employer hired the independent contractor to not only install but also maintain the IT system which is the center of IT operations, then the case will be hurt. This is because the roles of independent contractors should not be important functions for a company. If this fact is true, then the employer might be subject to IRS penalties (IRS, 2018). The other issue is paying the worker a monthly salary. Independent contractors are to be paid by the job. If it is true the worker was paid monthly as employees are paid, then the case will be hurt.
Common mistakes in hiring independent contractors
While hiring independent contractors, employees often misclassify them. In most cases, employees fail to understand the difference between an employee and an independent contractor. They end up misclassifying employees as independent contractors. While the practice leads to avoidance of paying the employee benefits and paying of some taxes, it comes with heavy penalties. Businesses are also left vulnerable to possible lawsuits that are usually costly. Second employees assume that a written contract is enough to determine employee status (Phin, 2014). However, it is the nature of the relationship between an employee and an employer that determines the classification. IRS and other related agencies look at other factors in determining the status of an employee. For example, they look at the degree of control.
An independent contractor has more control over work done compared to an employee. Independent contractors perform jobs that are highly skilled. The supply of work tools also determines employee status. If an employee supplies them then he or she is an independent contractor. Payment method determines the status. Time payment signals an employee rather than an independent contractor. Independent contractors are usually paid by a job as opposed to time as most employees do (Phin, 2014). It is thus a mistake to think that a contract supersedes other considerations. However, a contract is essential as it acts as a source of key information.
The other mistake employers make is making independent contractors work over 40 hours per week. Independent contractors usually have many clients considering that they are independent business people. Subjecting them to over 40 hours per week means that you are occupying their working life and hence is assumed that they are employees. Over 40 hours in a short time can be reasonable but for months, one is considered an employer (IRS, 2018). It is thus important that employers are keen on the number of hours they keep independent contractors per week. Employers also make a mistake of establishing a continuing relationship with independent contractors. A project that lasts more than six months should be handled through relationships that are based on temporary-service (Phin, 2014). Otherwise, under such conditions, one will be considered an employee.
Possible consequences for employee misclassification
If the IRS decides that the employee was misclassified, the worst thing that can happen is being heavily penalized. If the IRS establishes that the misclassification was intentional, then a penalty which is equal to the total tax amount that should have been withheld is given (Phin, 2014). Additionally, the employee is liable for 100% of the employer and worker share of Medicare and social security taxes. If the misclassification was unintentional but the filing was done, the penalty equals 1.5% of paid employee wages, 20% of the total amount that should have been withheld from worker Medicare and Social Security taxes and 100% shares of an employee from the taxes (Phin, 2014). If the misclassification was unintentional but the filing was not done, then the penalties change to 3%, 40%, and 100% consecutively.
Apart from IRS, there are other agencies that would be interested in worker misclassification mistake. First is the Department of labor at the state of federal level. Through its wage and hour division, the agency seeks to fight employee misclassification. The penalty depends on whether the practice was intentional or not (IRS, 2018). The Bureau of Labor statistics also helps the DOL in combating the vice and therefore would be interested in the mistake. Others are the agencies from state governments and courts who have also joined the fight against worker misclassification (Phin, 2014). Each agency applies a certain test in evaluating employee status.
Apart from the heavy penalty, there are other penalties that the employer might face. First, the US DOL might require a pay back wages dated back three years. Improper record keeping will attract fines (IRS, 2018). Additionally, another audit will be conducted which might lead to uncovering of other violations. State DOL and insurance agencies might seek back payments for the mistake (Phin, 2014). Other penalties are from the failure of complying with the Affordable Care Act. Under the ACA, an employer might be subjected to penalties of failing to offer coverage of the 95% of full-time employees. An employer can also be penalized for insufficient coverage by the ACA. One can face criminal penalties that go up to $1000 for the misclassified worker and or get a one year imprisonment (IRS, 2018). Additionally, the organization might suffer a tarnished reputation.
It is clear that intentional or unintentional employee misclassification attracts fines and penalties. In the case study, it is clear that the employer misclassified the worker. Timely payment, providing the tools, and long working hours signals the misclassification. The fact that the employer wanted an independent contractor could prove that the mistake was unintentional. This would help reduce the severity of the penalties. Some of the common mistakes made after hiring independent contractors is thinking the contract is the final say and misclassifying workers. IRS would give a heavy penalty for the worker misclassification. Other state agencies and DOL would also give the fines and penalties. Other penalties that can be faced are ACA related, criminal penalties, and imprisonment.
IRS (2018). Independent Contractor (Self-Employed) or Employee? Retrieved on October 19, 2018 from https://www.irs.gov/businesses/small-businesses-self- employed/independent-contractor-self-employed-or-employee
Phin, D. (2014). Hiring and managing independent contractors, pp. 1-9.