In today’s business world most employers would rather classify the people, who help them achieve their objectives as independent contractors rather than employees. There are some obvious differences between employers and employees:

1.   Employers must withhold taxes from employees while independent contractors pay their own employment taxes.

2.   Employers have vicarious liability for the acts of their employees like a car accidents caused by employees. An independent contractor’s accident would not make the employer liable.

3.   An employer must pay unemployment insurance and have Workman’s Compensation Insurance for employees, but not for the independent contractors.

It is not enough for an employer to classify a worker as an “independent contractor.” There are different tests under federal and state law as well as case law, which determine whether a person is truly an employee despite being called an independent contractor.

There can be serious consequences for an employer whose “independent contractor” is reclassified as an employee:

1.      Income Tax withholding.

If an independent contractor is reclassified as an employee, a significant liability arises out of the failure of the employer to withhold employment income taxes.

If the independent contractor is actually an employee and he/she did not pay his/her own income taxes, the employer could be required to pay the tax that should have been withheld from the payments that were made to the employee.

2.      Social Security Tax. Federal Insurance Contributions Act (FICA).

This is commonly referred to social security withholdings and is required on all wages up to an annual limit. People who are correctly classified as independent contractors are responsible for their own self-employment taxes. If a worker were reclassified from contractor to employee, the business would be responsible for paying half his contributions.

This can result in back payments of 7.65% due to the authorities on all money paid to the incorrectly classified independent contractor.

3.      Other tax responsibilities

These would include the federal unemployment tax and any unpaid state employment tax.

4.      Workman’s Compensation Insurance.

If a contractor is reclassified to being an employee, the employer could be responsible for the contributions it should have been made to workman’s compensation. In addition, the employer will be responsible for future premium payments.

5.      Health and Welfare.

In the past, an employee’s rights to these benefits have been dependent on whether the employer has had benefit plans for employees.

Under the new health care laws, the employer’s liability will be far greater.

6.      Reimbursed business expenses.

Many independent contractors agree to bear their own business expenses, but there are statutory rights, which an employee has to expenses incurred during the course of employment.

7.      IRS Penalty Assessments.

The amount of such penalty assessments will depend on whether the employer “deliberately” misclassified employees to independent contractors or whether there was no deliberate intent to misclassify such worker.

If the Service decides that the employer deliberately misclassified workers, it can hold the employer responsible for all employment taxes that should have been paid, including income tax and the employer’s share of FICA and unemployment taxes. What could be worse is that the IRS is not limited to getting paid from the employer; it can attach the personal assets of officers, even in a limited liability company or corporation.

Conclusion

It is important that an employer correctly classifies business workers as either employees or independent contractors at the time of hiring services.