Employee misclassification happens when an organization labels workers as independent contractors rather than employees. Misclassification denies employees of the benefits they may be entitled to such as paid overtime and health insurance. In addition, this practice enables employers to avoid certain obligations such as paying unemployment taxes.
Employee misclassification can attract severe penalties from both the state and federal governments. Intentional or not, a misclassification puts the organization at risk for owing unpaid taxes and employee benefits. Here are two ramifications of employee misclassification that can hurt your organization.
IRS penalties can be costly to the organization. If the IRS establishes an employer-employee relationship, it might compel the practicing organization to backdate tax withholdings as well as FICA (Social Security and Medicare) taxes.
Specifically, the IRS can subject the business to the following penalties:
- A $50 fine for every W-2 the employer did not file for the identified employees
- A fine of 1.5% of the identified employee’s salary
- Withheld FICA taxes
Legal authority penalties
The Department of Labor takes employee misclassification seriously. In fact, in recent years, the department has hired special auditors to help identify and penalize businesses that misclassify their workforce. An organization that misclassifies its employees, and this violates the Fair Labor Standards Act that guarantees minimum wage and employee protections, is liable for applicable criminal penalties as well as backdated wages. Organizations that are found guilty of employee misclassification may be subjected to the following legal penalties:
- Criminal penalties of up to $1,000 for every misclassified employee
- Class-action lawsuit
- Wage claims audit
- Workers’ compensation violation penalty
- Repayment of benefits
- FMLA benefits payments
Employee misclassification is a costly mistake that can happen to any organization. However, taking the right preventive measures can save your business a great deal of money in the form of fines and penalties.