The Real Cost of Employee Misclassification

Trying to dodge paying federal withholding tax does not pay off. Intentionally misclassifying an employee as an independent contractor comes with consequences from the Internal Revenue Service (IRS), including liability for the full amount of federal income tax and 100% of the employee and employer share of Social Security and Medicare taxes. These employers are also subject to other penalties such as:

-Interest accrued from the day those taxes should have been deposited.

-Fifty dollars per W-2 that should have been filed.

-'Failure to Pay Taxes' penalty equal to .5% of the unpaid tax liability for each month, up to 25% of the total tax liability.

-Criminal penalties of up to $1,000 per misclassified person.

-Potential jail time - up to one year.

For those who unintentionally misclassify their workers, the penalties are less severe, but still exist. They include:

-For not withholding the proper taxes, the tax assessed is 1.5%, which can be double to 3% if the employer fails to file information return for the worker to the IRS.

-For not withholding Social Security and Medicare, the tax is assessed is 20% on just the employee’s share. That is double to 40% again if the employer does not file information returns.

Employers who intentionally and unintentionally misclassify workers are subject to fines and penalties at the state level, too. State penalties vary from state to state. For employers who want to rectify a mistake or need to change the status of an employee to avoid the above penalties, there is a method.

Voluntary Classification Settlement Program

The Voluntary Classification Settlement Program (VCSP) allows taxpayers to voluntarily reclassify workers as employees for future tax periods. Taxpayers will pay 10% of the amount of employment taxes due on compensation paid to the worker being reclassified and the taxpayers will not be liable for penalties or interest. After successfully beginning the VCSP, taxpayers will also not be subject to audits for prior years in respect to worker classification. Those employers could still be audited for other tax related issues, however.

Not all workers have to be reclassified under the VCSP, but if an employer reclassifies one class of worker, everyone in that same class or level must be reclassified. Only taxpayers who wish to reclassify their independent contractors and have consistently treated the workers as non-employees in the past are eligible for the VCSP. Taxpayers currently being audited cannot qualify.

Do you have any experience reclassifying workers? Let us know on PayrollTalk!