Employee
misclassification has become an increasingly common issue in the business
world. US Labor law allows employers to secure the services of independent
contractors, but some unscrupulous employers attempt to use this privilege to
avoid following fair business practices.
Correctly classifying
employees is an important business responsibility. Misclassification can affect
labor standards such as minimum wage and overtime requirements. Additionally,
employers can avoid paying unemployment insurance, payroll taxes by using
independent contractors. Unethical employers can also skirt safety and health
issues and neglect to pay workers' compensation insurance by not “hiring”
employees.
There is More Than One
Type of Misclassification
Employee
misclassification can occur when an employee is registered as a contractor by an
employer either deliberately or in ignorance. However, there are other methods
employers can use to misclassify employees:
- Employers
can misrepresent the type of work an employee does since insurance can be
cheaper for the clerical worker than it is for a drywaller
- Some
employers pay workers in cash instead of using paychecks; these types of
workers may aren’t classified at all.
Employee
Misclassification Violates Fair Business Practices
US Labor law stipulates
that employers are liable to pay various benefits and taxes for their
employees; businesses are not required to do this for independent contractors.
Therefore, an employer who has employees but doesn’t classify them correctly
has lower labor expenses then the employer who classifies employees
correctly.
If both employers are
engaged in similar businesses, then misclassification can give one employer an
unfair advantage over the other employer. This is not an acceptable practice;
it goes against the rules of fair trade. Some employers do incorrectly classify
employees out of ignorance, but many employers do so deliberately for financial
gain.
The Employer’s Incentive
to Incorrectly Classify Employees
What does the
unscrupulous employer stand to gain by misclassification? NECA estimates that
unscrupulous employers can save about 30% of payroll costs by not classifying
employees correctly. In extremely competitive sectors like construction and
infrastructure, which are highly labor-intensive, this margin is more than
enough to provide an unfair advantage to an unscrupulous employer.
The misclassified
employee misses out on social security, health care insurance, Worker’s
compensation premiums, and unemployment insurance benefits. However, it is the
Government and taxpayers who lose the most, in the form of billions of dollars
of tax revenues from uncollected Social Security taxes, unemployment insurance
taxes, and income taxes.
Penalties for Employee
Misclassification
No wonder, the IRS is
continuously is upgrading its efforts to locate offenders. If an employer is found
guilty of the felony, the business is fined 3% of payroll. In addition, he has
to pay the full amount of social security taxes and 40% of the employee’s
share. Employers who accidentally classify an employee incorrectly can qualify
for relief under Sec 503, provided the employer can prove a “reasonable basis”
for the employee misclassification.
Before launching a new
business, it is best to take professional advice from a lawyer who specializes
in payroll taxes and business accounting issues. The legal advice charges may
appear to be costly,but employee misclassification can end up costing a
business much more.
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