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How To Properly Classify Independent Contractors

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How-To-Properly-Classify-Independent-Contractors-Last month, Uber, America’s giant international transportation network company, suffered its second setback in its recent case regarding independent contractor misclassification. The judge ruled that the two claims made by drivers, that Uber illegally withheld a portion of drivers’ tips, could proceed as a class action claim.

What Happens To Uber Employees?

What the court will now decide is if these drivers are indeed employees, not independent contractors as Uber claims, and therefore are entitled to their full tips. What’s at stake for Uber? Should they lose the case and need to convert all drivers’ status from independent contractors to employees, it will cost Uber tens of millions of dollars, or more; not to mention it could overturn the business model that has made them one of the world’s most respected companies of its kind, with a valuation close to a whopping $51 billion.

The employee versus independent contractor debate is a hot one right now, as the Department of Labor and IRS are cracking down on misclassifications.  As an employer, it is critical to understand the differences between the two classifications to ensure you are complying with federal and state tax laws and employment regulations.

For employees, employers and employees are required to pay taxes, such as unemployment insurance and Social Security, and employers are required to provide other benefits, such as workers compensation insurance.

IRS Employee Classifications

In order to make a precise determination in whether an individual is an employee or independent contractor, there are three classifications per the IRS to be measured:

  • Behavioral: Does the company control how the worker completes their job and what is exactly is expected of them in that role?
  • Financial: Does the company control the business aspects of the worker’s job such as, how the worker is paid, whether expenses are reimbursable, and providing the tools needed to perform?
  • Type of Relationship: Are there written contracts or employee-type benefits (i.e. insurance, vacation pay, etc.)? Does the relationship end once the work is completed? Is the work carried out a key facet of the business?

In Uber’s case, the independent contractor classification is still up for debate. Although drivers use their own car and incur expenses themselves, many will argue that Uber treats them like employees and controls almost all aspects of their job once they choose to accept a ride.

Similarly, there will be many drivers who say they are independent contractors and want to remain that way. After a lengthy and costly legal battle, one side will eventually win out.

Penalties For Misclassifying Employees

So what happens if an employer is caught misclassifying employees? Once a complaint has been investigated, the consequences for an employer can differ depending on whether or not the misclassification is deemed to be unintended or deliberate.

Most employers that have misclassified deliberately do so, quite simply, to avoid spending additional money on taxes and benefits. Even if the misclassification was accidental, the employer faces, at a minimum, the following fines, based on the notion that all payments to misclassified independent contractors are re-classed as wages:

  • $50 For each Form W-2 that the employer failed to file because of classifying workers as an independent contractor.
  • Penalties of 1.5% of the wages, plus 40% of the FICA taxes (social security and Medicare) that were not withheld from the employee, and 100% of the matching FICA taxes the employer should have paid. Interest is also accrued on these penalties daily from the date they should have been deposited.
  • A Failure to Pay Taxes penalty equal to 0.5% of the unpaid tax liability for each month up to 25% of the total tax liability.

How To Properly Classify Employees 

Since the U.S. government takes this issue very seriously, you should be very diligent in making sure you are classifying your employees correctly. If you are unsure of a workers’ status, you can fill out a Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Withholding) and send it in to the IRS for their determination on the matter.

Going forward, a company like Uber can still make positive changes towards compliance in the midst of their case. Those types of changes can be done in the near future through restructuring, re-verifying and re-executing the independent contractor relationship. 

Cristina AmyotThis is a guest article written by Cristina L. Amyot. Ms. Amyot is the President and CEO of EnformHR, LLC, a human resources consulting firm based out of Red Bank, New Jersey. Ms. Amyot and her team of HR Generalists provide a full range of customized HR services, helping companies protect and grow their business, including: HR Management, Training & Development, and Strategic Partnering.


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