What's Your Financial Risk For Classifying Employees As Independent Contractors?

The ramifications for an employer can vary depending on whether or not the Department of Labor ("DOL") and the IRS determine the misclassification was unintentional or intentional, or even fraudulent.

If the misclassification was unintentional, the employer faces at least the following penalties, based on the fact that all payments to misclassified independent contractors have been reclassified as wages

$50 for each Form W-2 that the employer failed to file because of classifying workers as an independent contractor.
Since the employer failed to withhold income taxes, it faces 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.

If the IRS suspects fraud or intentional misconduct, it can impose additional fines and penalties.

For instance, the employer could be subjected to penalties that include 20% of all of the wages paid, plus 100% of the FICA taxes, both the employee's and the employer's share.
Criminal penalties of up to $1,000 per misclassified worker and one year in prison can be imposed as well. In addition, the person responsible for withholding taxes could also be held personally liable for any uncollected tax.

Example: ABC Company paid an independent contractor $40,000. The IRS subsequently determined that the classification was incorrect, and that the proper treatment should have been as an employee. The IRS assessed payroll fees would be approximately $26,667 for a one-year time period. The IRS typically audits three years at time. If the worker was misclassified per year, the additional assessment could be as much as $80,000 before interest and penalties!