Misclassification of Workers - Independent contractor vs. Employee

By: Brian McMahon | Posted: 01st December 2008

Independent Contractor versus Employee

Misclassification could be costly



by

Brian P. McMahon, Esq.



(Originally published in the Troff, Petzke & Ammeson Newsletter at www.tpalaw.com/Newsletter)





 

Recently the State of Michigan created the Interagency Task Force on Employee Misclassification. The purpose of this task force is to investigate employers suspected of misclassifying its workers.

 

"Misclassification" occurs when an employer treats a worker as an "independent contractor" when the worker should be classified as an "employee." The motivation for employers to misclassify its employees as independent contractors is the fact employers can avoid having to withhold income taxes, and other typical wage withholdings as well as avoid having to pay unemployment insurance and workers compensation insurance. To avoid these costs the employer issues the "independent contractor" an IRS Form 1099-Misc. or, in some cases pays the worker "under the table." The independent contractor, in turn, is then responsible for paying all the typical withholding taxes. The problem is that the worker often intentionally fails to pay these taxes or is unaware of their obligation to pay these taxes. In either event, the State of Michigan looses tax revenue, payments into the unemployment insurance fund and other money typically collected from wages paid to "employees." In addition, the State of Michigan is concerned with the fact these workers who are misclassified suffer because they are not protected by employment laws, do not qualify for unemployment insurance benefits, and in some cases are not covered by the workers compensation program if they are injured on the job.

 

The risk to the employer if it misclassifies it workers is great. Not only does the employer face being held responsible for payment of the taxes it should have withheld from the "employee's" wages, it will likely be responsible for paying the "employee's" portion of these taxes as well. However, the amount of taxes the employer is required to pay often pales in comparison to the penalty, interest and other remedies assessed by the State of Michigan and/or the Internal Revenue Service ("IRS"). The problem gets even worse because the owners of the business, or at least the person responsible for making sure taxes are withheld from employees' wages, may be held personally liable to pay these taxes if the corporation cannot. In addition to having to pay taxes, penalty and interest, an employer who misclassifies a worker, and therefore does not obtain workers compensation insurance, may loose the protection provided by Workers Disability Compensation Act. That is, an employer, unless grossly negligent, cannot typically be sued by an employee who is injured on the job if the employer has workers compensation insurance coverage. Without this coverage, an employer could face a lawsuit resulting in a judgment against it in the 100s of thousands of dollars as a result of injuries to a person determined to be an employee.

 

My experience representing clients in audits involving misclassification have, up to this point, been initiated by the IRS. Although there are a number of ways an IRS audit is prompted, a common scenario involves the IRS trying to match up the social security number on a 1099-Misc with an IRS Form 1040. When no corresponding 1040 is found, the worker receiving the 1099-Misc is audited. If the IRS determines the worker is not an "independent contractor," the IRS then audits the employer and reviews all of the 1099-Misc. issued by that employer. To learn more about how the IRS defines "employees" go to Independent Contractor versus Employee.

 

Currently the State of Michigan's task force is holding public hearings throughout the state of Michigan and has established a hotline to take calls regarding businesses suspected misclassifying its workers. Persons expected to use the hotline include not only workers who are misclassified (because they are audited, fail to qualify for unemployment insurance, are injured at work, etc.) but also other businesses who suffer a competitive disadvantage when competing for contracts against businesses that do not have to take into account the cost of compliance when making its bid. For this reason I suspect businesses involved in the construction industry will be a common target of the task force. To learn more about how the State of Michigan defines "employees" go to economic reality test.

 

To veiw this article with hyperlinks and/or to subscribe to the Troff, Petzke & Ammeson quarterly Electronic Newsletter, go to:

www.tpalaw.com/Newsletter.



by:



Brian P. McMahon, Esq.

Partner

Troff, Petzke & Ammeson

811 Ship Street, Suite 202

St. Joseph, MI 49085

(269) 983-0161



or



Brian P. McMahon, Esq.

Partner

Troff, Petzke & Ammeson

121 W Merchant Street

New Buffalo, MI 49117

(269) 469-9388



 
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Tags: wages, motivation, obligation, independent contractor, independent contractors, income taxes, workers compensation insurance, state of michigan, employment laws