Employees, Contractors, and Audits: Why Misclassification Matters

  • March 14, 2019
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Employees, Contractors, and Audits: Why Misclassification Matters

In recent years, economic shifts and advancements in technology have led to unprecedented growth in the independent and freelance workforces. It shouldn’t surprise anyone then that companies are turning more and more frequently to independent contractors to fill vacancies that were previously filled by traditional employees.

These companies need to exercise caution when taking on independent contractors, however. Classifying one of your workers as an independent contractor when they should, according to IRS standards, be classified as an employee can leave you open to organizational audits and misclassification lawsuits.

Employees v. Contractors – What’s the Difference?

Employers can find themselves tempted to classify their employees as independent contractors because it frees them from the responsibility of withholding the worker’s payroll taxes. Payroll taxes include things like Social Security, Medicare, and Federal Unemployment that are automatically deducted from W-2 employees.  Independent contractors, however, are responsible for their own payroll taxes.

In theory, this practice splits the tax burden equally between employer and contractor. The fact of the matter is that this isn’t always the case. From 2010 to 2015, the IRS reports that the number of taxpayers who were penalized for underpaying their estimated taxes rose nearly forty percent. The freelance economy and misclassification are believed to be driving factors.

If you’re unsure whether you’ve classified your workers properly, then get in touch with us today for an employment law compliance review. If you know for a fact that you’ve been misclassifying them, don’t worry – we can help with that, too.

How Misclassification Can Trigger an Audit

The federal government really doesn’t like misclassification and they’re more than happy to lay down an organizational audit against those that they believe to be less than compliant. These audits often strike unexpectedly and can be debilitatingly expensive in terms of time, energy, and money. In the most extreme situations, employers have even been hit with fines, criminal penalties and more as a consequence.

The problem starts when you treat your independent contractors like traditional W-2 employees. Doing so makes it look like you’re just trying to avoid paying the IRS what it’s owed. This includes training them on the job, requiring specific hours and/or a set schedule, and requiring them to take on the same responsibilities of actual employees. Most organizational audits are brought about by whistleblower reports, when a contractor files for unemployment benefits, or when a worker files a request for classification determination with form SS-8.

Organizational Audits and How to Survive Them

Notice of an organizational audit by the IRS comes by snail mail. The letter includes the justification for the audit and instructions on what to do next.

No matter the reason for the audit, your first move should be to find and retain a lawyer with experience in tax and labor law. Your lawyer is one of the best allies that you will have through this intimidating process. Having the right counsel makes it easier to gather the necessary information and documents, including 1099s, bank statements, income tax returns, and financial statements. Their extensive legal training means that they can spot instances of misclassification or outright fraud that business owners could miss.

You should be prepared to provide the aforementioned documents to the auditor. You will likely need to meet with them to review cases or information that they find questionable, too. When it comes to negotiating settlements, penalties, or fines, don’t worry – that’s what you hired your counsel to handle for you.

Prevention v. Cure

Audits are a lot like disease – an ounce of prevention is worth a pound of cure. Regular internal audits of company policies, practices, and records can alert you to any issues before they grow into full-blown problems. Ensure that your internal policies and procedures for classifying your workers are in line with state and federal regulations. Remember, even honest mistakes can lead to audits just as easily as outright violations.

Another critical component to properly classifying your workers is to always use written contracts. These can serve to protect your business by defining the individual as a licensed and insured independent contractor with agency over their own responsibilities. Hold on to any documents that could help you back up your classifications, too. For comprehensive protection, consider hiring a lawyer to assist with drafting your employment and independent contractor agreements.

Looking to start a business or grow your current business? Contact FL Patel Law today by visiting our website, www.FLPatelLaw.com, or calling 727-279-5037.


Tyler Thompson is a second generation St. Petersburgian with a passion for reading and writing. In 2018 he finally made his way to FL Patel Law PLLC where he has found a home for himself as Project Manager. He is an unapologetic dog person who enjoys spending what free time he has with his friends and family.

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