[Previously in Part 1, we discussed the impact of the mischaracterization of employees as independent contractors and various government action to enforce proper classification of the workers. Today, we will discuss some of the consequences of misclassification and the steps to help avoid misclassification problems.]
Consequences of Misclassification
The financial penalties for improper classifications are stiff and include those imposed by State and Federal governments. The employer’s penalties will be assessed under Internal Revenue Code 3509, which includes potential liability for unpaid federal and income tax, social security tax, unemployment tax, penalties for failure to provide workers compensation, unpaid overtime and attorney’s fees. Under the Workers Compensation Act, the employer exposes himself to tort liability for injuries to employees when workers’ compensation was not properly available and secured. An intentional failure to provide workers’ compensation to an employee is a serious offense and may result in a Class H felony. Those who simply neglect to provide workers’ compensation can be charged with a Class 1 misdemeanor. Additionally, an employer who fails to provide workers’ compensation coverage can be fined one dollar per employee per day, but not less than $50 per day and not more than $100 per day.
Wood Framing by Construction Workers
How to Avoid the Problem
General contractors first need to take notice that if they are hired to build a publicly-funded project, they must sign a contract agreeing to follow all federal and state laws and to make sure the subcontractors they hired do so as well.
To avoid potential penalties by properly classifying the workers, contractors can follow three tests provided by the IRS, the Department of Labor, and the North Carolina courts. Although there is no clear definition for “employee” or “independent contractor,” the following is a list of common factors that appear throughout those three tests to help determine whether your worker is an employee or an independent contractor:
- Does the worker have control of how or when the work is completed?
- A worker who must comply with the employer’s instructions suggests an employee-employer relationship. An employer who determines when, where, and how work is completed also suggests an employee-employer relationship. Independent contractors, on the other hand, have the freedom to determine when and how the work will be completed.
- Can the worker realize a profit or suffer a loss as a result of the worker’s services?
- An employee generally will not realize any profit or loss in addition to their ordinary compensation. Additionally, employees are typically paid hourly whereas, independent contractors are paid in accordance with a contract. Independent contractors risk incurring loss if they fail to complete the project within the contracted amount.
- Does the worker supply his own tools, materials, or equipment?
- A worker who uses a significant amount of tools belonging to the employer is typically an employee. Additionally, a worker who is reimbursed for job related materials also suggests an employee-employer relationship.
- Does the business depend on the services rendered by the worker for its success or continuation?
- Integration of the services provided by the worker into the business operations suggests an employee-employer relationship. The success of the business does not have to be solely dependent on the work performed by the worker but if the business’s success is substantially dependent on the work performed, the worker is generally an employee. Independent contractors typically provide services that are not a key activity of the business.
- Is there a continuing working relationship between the worker and the person for which the services are employed? Is the worker providing services for another client?
- A continuing relationship, even one with irregular intervals, suggests an employee-employer relationship. A worker who works only with one business or is required to devote substantial time (i.e. work “full-time”) to the business is generally an employee while an independent contractor typically provides services to more than one client and is retained for a specified period of time.
- Has the worker received any training from other workers on the project or are they required to work with an experienced employee?
- Training a worker by requiring an experienced worker to work with the worker or any other method of training provided by the employer suggests that the employer wants the services performed in a specific manner. Requiring services to be performed in a specific manner is indicative of an employer-employee relationship.
No particular factor is controlling, however the determination should be made on a case-by-case basis and the factors taken together as a whole should indicate how the worker should be classified.
If it is still unclear whether a worker should be classified as an employee or an independent contractor, the business or the worker can file a Form SS-8. The IRS will review the facts and circumstances to make a determination of the status of the worker.
Remedies for Previous Misclassification
The IRS Voluntary Settlement Program, provides businesses the opportunity to reclassify their workers as employees for future tax periods and provides businesses with partial relief from federal employment taxes for eligible taxpayers.
Workers who have been misclassified as independent contractors can file an IRS Form 8919,which will be used to calculate the employee’s share of uncollected social security and Medicare taxes due on their compensation. To collect their share of social security and Medicare taxes, the worker must meet one of the criteria specified on IRS Form 8919, indicating that they were misclassified.
Conclusion
It is important contractors pay attention to the issue of classification of workers and classify workers properly to avoid liability. Contractors should evaluate the status of their workers individually by allowing the determination to be made on a case-by-case basis. When applying the worker status factors to your case, remember that no element of the test is decisive and the determination should be made by taking into consideration the totality of the circumstances. If you have further questions about how to classify your workers or about potential misclassification of workers, please contact your local construction attorney.