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Blog


9 CONSEQUENCES OF MISCLASSIFYING YOUR 1099 CONTRACTORS

May 02, 2023

5 min read


The classification of 1099 contractors and W-2 employees is always a high
priority topic for organizations looking to continue expanding their use of
independent contractors; and with good reason.

The cost of non-compliance can be staggering. Fines levied by the U.S.
Department of Labor (DOL), IRS and state agencies for worker misclassification
can exceed millions depending on the severity of the infractions. The threat of
class action lawsuits should also serve as a further deterrent for companies
straddling the boundaries of improper classification.

As more and more companies begin leveraging independent contractors, it’s
paramount that HR executives and CHROs and are armed with all the information
they need to mitigate compliance risk and properly classify their workers. The
following is a list of some of the consequences of misclassifying a worker as an
independent contractor. While this isn’t an exhaustive list, these risks alone
highlight the critical need for companies to take proper steps to ensure their
contractors and employees are properly classified.


1. WAGE LAW VIOLATIONS

Employers that hire individuals as independent contractors who should in fact be
classified as employees may be held liable for failure to pay overtime and
minimum wage under the federal Fair Labor Standards Act (FLSA) and applicable
state wage laws. The statute of limitations for an individual to file a wage
claim under the FLSA is 2 years for a non-willful violation and 3 years for a
willful violation. (“Willful” means the employer knew, suspected or had reason
to know that their actions might violate the FLSA).

Both criminal penalties and liability for back wages may be levied against
employers and executives found in violation of FLSA laws. This is an area of
intense focus by the DOL, who has recently hired many new investigators in an
effort to review wage compliance, which would include ensuring that employers
are not improperly classifying workers as independent contractors.

In addition, the potential civil liability exposure for companies that
misclassify workers is huge. Employers found in violation may incur massive
penalties, including unpaid overtime costs and minimum wage deficits – plus
liquidated damages equal to unpaid wages and attorney’s fees.


2. UNPAID EMPLOYMENT TAXES

For workers found to have been misclassified as independent contractors,
employers may also face penalties for failing to withhold and remit state and
federal payroll taxes, including failure to make social security and Medicare
tax payments.


3. I-9 VIOLATIONS

Workers that are misclassified as independent contractors could also create
employer liability relating to employer verification requirements. Specifically,
employers are obligated to keep properly filled out Form I-9s on file for each
of its employees. An employer could be subject to an audit of its Form I-9
records by the Department of Homeland Security, Immigration and Customs
Enforcement (ICE) and the Department of Labor. If an employer misclassifies an
individual as an independent contractor, they will not have the required Form
I-9 on file and could be subject to penalties that include civil fines, criminal
penalties, debarment from government contracts, and court orders. Form I-9
audits often target industries where labor might not be closely controlled, such
as construction, home healthcare, warehousing, and poultry processing.


4. UNEMPLOYMENT INSURANCE SHORTFALLS

Another potential cost of misclassification may be penalties for failure to pay
state unemployment insurance for the individual. The issue typically is whether
the Employer’s Quarterly Wage List and Employer’s Contribution Report submitted
by the employer to Workforce Services accurately reports the number of
employees, as these are the reports the contribution rate is based upon.


5. UNPAID WORKERS’ COMPENSATION PREMIUMS

Misclassification can also result in penalties for violation of state workers’
compensation insurance laws and liability for unpaid workers’ compensation
premiums. Additionally, claims from an individual misclassified as an
independent contractor will be the employer’s sole responsibility and will not
be covered by the employer’s workers’ compensation insurance policy.


6. IMPROPER EXCLUSION FROM BENEFITS

Misclassified workers may be entitled to receive or participate in an employer’s
employee benefits, including pension and other retirement plan coverage, health
insurance plan coverage, paid leave allowances, and severance pay, among others.
There is often a lot of enforcement and lawsuits relating to failure to provide
benefits, so here too there is the potential for substantial liability.


7. ANTI-DISCRIMINATION VIOLATIONS

Misclassification may also result in failure to provide required protections to
individuals under state and federal anti-discrimination laws. Those workers
improperly classified as independent contractors could be entitled to certain
notice obligations and enforcement protections relating to these laws. An
employer’s violation of any of these rights could result in agency charges of
discrimination or lawsuits for failure to provide these required protections.


8. FAILURE TO PROVIDE JOB-PROTECTED LEAVE

If an individual should have been classified as an employee, employers may have
certain obligations to provide leave to eligible employees under applicable laws
like the federal Family and Medical Leave Act (FMLA) and the Uniformed Services
Employment and Reemployment Rights Act (USERRA). Failure to provide protected
leave, reinstate individuals that took protected leave, or retaliate against
individuals that requested or took protected leave could result in legal claims
against an employer.


9. FAILURE TO PROVIDE REQUIRED NOTICE

Employees are also entitled to notice under many different laws, and failure to
properly classify an individual as an employee could affect the employer’s
compliance with these laws. For example, failure to count misclassified workers
when determining federal WARN Act and state mini-WARN Act compliance obligations
in the event of mass layoffs and plant closings, as well as failure to give
required WARN notices to affected misclassified workers under these laws, could
result in employer fines, back pay, and other penalties for non-compliance.


THE BOTTOM LINE: YOU CAN’T AFFORD TO MISCLASSIFY

The misclassification of workers significantly impacts the individual worker,
the employer, and the economy at large. At the same time, individuals are
increasingly seeking roles as independent contractors to control how they engage
for work. No single factor determines misclassification, making the complexities
of worker status even more arduous to manage. Because of the great cost of
misclassification and the additional DOL investigators available to challenge
your worker classification, it is more important than ever to ensure you are
correctly classifying your workforce.

To learn more about best practices for properly managing your independent
contractor workforce, download our Business Guide to Freelancer Trends and
Practices.



The information provided in this article is for informational purposes only and
not for the purpose of providing legal or tax advice. The information and
services WorkMarket provides should not be deemed a substitute for the advice of
any such professional. Such information is by nature subject to revision and may
not be the most current information available.


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