Be Sure You Are Classifying Properly – Employee (W-2) vs. Independent Contractor (1099)
Misclassifying employees as independent contractors can quickly get a company into hot water. Expensive penalties can be assessed to Colorado employers who fail to property classify independent contractors from the State of Colorado, and also from the Internal Revenue Service (“IRS”).
If You Do Any of the Following with an Independent Contractor, You May Be Misclassifying
- Require the individual to work exclusively for the company for whom services are performed – except that the individual may choose to work exclusively for such person for a finite period as specified in a contract/document.
- Establish a quality of standard for the individual – except that the company may provide plans and specifications regarding the work, but cannot oversee the actual work or instruct the individual as to how the work will be performed.
- Pay a salary or pay at an hourly rate instead of at a fixed or contract rate.
- Terminate the work of the service provider during the contract period, unless the service provider violates the terms of the contract or fails to produce a result that meets the specifications of the contract.
- Provide more than minimal training for the individual.
- Provide tools or benefits to the individual – except that materials and equipment may be supplied.
- Dictate the time of performance – except that a completion schedule and a range of negotiated and mutually agreeable work hours may be established.
- Pay the service provider personally instead of making checks payable to the trade or business name of such service provider.
- Combine the business operations of the company for whom service is provided in any way with the business operations of the service provider instead of maintaining all such operations separately and distinctly.
Colorado Department of Labor and Employment Investigations and Penalties
The Department of Labor, under the Fair Labor Standards Act, has well-established tests and procedures for determining an individual’s employment status.
In Colorado, if a complaint is filed and a resulting investigation finds that an employer has misclassified employees, the employer must pay all back unemployment insurance premiums owed with interest.
Additionally, if the investigation finds that the misclassification was a willful disregard of the law, the employer may be fined up to $5,000 per misclassified employee for the first misclassification, and up to $25,000 per misclassified employee for a second or subsequent misclassification.
IRS Determinations and Penalties
The IRS utilizes its own test and factors in evaluating the degree of control and the degree of independence exercised by the individual in the performance of their duties. The IRS considers three factors, taken together, in making the determination of employee status for purposes of an employer’s obligations for employment taxes accrued for a worker:
- The Behavioral Factor – explores whether the employer has the right to control the work performed by the worker.
- The Financial Factor – asks who supplies the tools and supplies needed by the worker, how the worker is paid, and whether the worker is free to offer services to others in the relevant market.
- The Relational Factors – examine whether the worker has a written contract or benefits provided by the employer.
Earnings of employees are subject to FICA (Social Security and Medicare) and income tax withholding. If the IRS determines that an individual has been misclassified, it may levy penalties against the employer including, but not limited to:
- A $50 fine for each Form W-2 the employer failed to file on such employee,
- A penalty of up to 3% of the wages, plus
- Up to 40% of the FICA taxes that were not withheld from the employee and up to 100% of the matching FICA taxes the employer should have paid.
- If the IRS determines the misclassification to be intentional and willful, the penalties are even greater.
Better Safe Than Sorry – Utilize a Temporary Staffing Service for Payrolling
Instead of questionably classifying some workers as independent contractors, companies can always turn to Payrolling a worker they have recruited and identified on their own through a temporary staffing firm such as J. Kent Staffing.
If you are not wanting to add a W-2 employee to your headcount, the staffing agency can be the Employer of Record instead of you. The staffing agency is responsible for issuing the year-end W-2 and for all payroll tax withholdings, remitting taxes to all federal, state, and city governments, and also for providing workers’ compensation insurance for its employees.
This article does not constitute legal advice. Employers should exercise caution and seek legal counsel in categorizing employees versus independent contractors in their workforce.
- Colorado Department of Labor and Employment website/Misclassification
- JDSupra, June 16, 2021. “2021 Update – IRS Misclassifications and Costly Penalties: Independent Contractor or Employee”, written by Cayman Caven, Burr & Forman.
- “Q&A: managing the employment relationship in the USA”, Holland & Hart LLP. Lexology author, Rob Thomas. October 1, 2021.
Need to Have a Worker Payrolled?
Contact J. Kent Staffing to learn about our Employer of Record payrolling services.