A Business Owner’s Guide to Employee Misclassification

About 36% of workers are part of the gig economy. By 2027, that number should exceed 50%.

More people realize that they’d rather work for themselves. It brings more freedom and flexibility to their schedules. They can do their work and take time off to take care of kids or go to the doctor.

For businesses, the gig economy brings many advantages. You have a free market of workers to choose from.

Before you dive into the gig economy to hire workers, you need to know about employee misclassification.

There could be a lot of unintended consequences if you don’t classify your workers properly. Read on to learn what it is, why it’s important, and how to classify your workers.

What Is Employee Misclassification?

Employee misclassification is the practice, deliberate or not, of classifying workers as contractors when they should be classified as employees.

This determination is usually made by the IRS or state tax authorities.

Why is this issue such a big deal for the IRS and state treasuries? One of the reasons why businesses avoid classifying employees is because they have to pay payroll taxes.

Contractors can write off business expenses to lower their tax liability. Employees can’t write off most business-related expenses.

Federal and state governments rely on these taxes to function and provide essential services.

It’s also a worker’s rights issue. Employees have rights to certain benefits under labor laws, such as worker’s compensation benefits.

The Importance of Classifying Workers

There are serious consequences of employee misclassification, even though there are some benefits for businesses and contractors.

Companies get charged with employee misclassification penalties. You might have to pay back taxes, retroactive benefits, and additional penalties.

You could also face an employee misclassification lawsuit from employees and tax agencies. One such case is where a worker sued a delivery company for employee misclassification.

The case is making its way through the legal system. This case and others could bring major changes to how employees get classified.

How to Properly Classify Employees

There isn’t a law that draws a clear line between employees and independent contractors. Employers have to tread carefully to make sure that they classify their workers.

The IRS has a three-point test to use when classifying workers. These are guidelines to use to ensure you file the right forms when you file taxes.

It comes down to control over the worker. If you dictate how and when the worker performs the work, that’s an employee.

Companies that control expense reimbursement and provide materials to perform the work have employees, not contractors.

If the employee is hired for a short period of time, they’re likely to be a contractor. In that case, you’ll use a service similar to eFile 360 to create 1099 forms.

Avoid Employee Misclassification

You have to make sure that you classify your workers properly. Employee misclassification has serious consequences for your business.

It’s your responsibility to understand the laws, so you can avoid employee misclassification penalties. If you’re not sure, use the IRS guidelines to classify your workers.

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