Misclassification of employees as independent contractors

Misclassification of employees as independent contractors in the United States can occur with respect to tax treatment or the Fair Labor Standards Act.

IRS reclassification as an employee occurs where persons claimed as (or claiming to be) independent contractors are recategorized by the Internal Revenue Service (IRS), or by state tax authorities, as W-2 employees. The reclassification can result in the imposition of fines, penalties, and back-taxes for which the employer is generally liable. These amounts could cost a business large sums of money. The U.S. Government Accountability Office (GAO) (formerly known as the General Accounting Office) reports that the IRS claims to lose millions of dollars in uncollected payroll, social security, Medicare, and unemployment insurance taxes because of misclassification of independent contractors by taxpayers. According to IRS Commissioner Mark W. Everson in a statement made November 3, 2005, IRS audits of small businesses organized as corporations increased from 7,294 in 2004 to 17,867 in 2005. [1]

Employers must report the incomes of employees and independent contractors using the IRS form W-2 and 1099, respectively. Employers pay various taxes (i.e. Social Security and Medicare taxes, unemployment taxes, etc.) on the wages of a worker that is classified as an employee. However, these same taxes are generally not paid by the employer on the compensation of a worker classified as an independent contractor. Instead, the worker classified as an independent contractor is responsible for their employer's share of the taxes when he or she pays self-employment taxes at the end of the year. If an employer intentionally or mistakenly classifies an employee as an independent contractor, the employer is then at risk for being heavily fined and paying back-taxes.

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