Business Law

Protect Your Business from the Pitfalls of Employee Misclassification

Home > Blog > Business Law > Protect Your Business from the Pitfalls of Employee Misclassification

Business owners face many challenges today and as a result, are always looking for ways to cut down and control as many costs as possible. However, when it comes to making decisions concerning employees, it can be tempting to make risky choices about how you should classify your workers. Whether in regard to a new hire or an existing employee, you must be certain you are making well-informed decisions about what category you place them in and why.

As employers struggle with the high cost of taxes and health benefits (among other expenses) for their employees, it can be appealing to convert their status to that of an independent contractor or non-exempt employee in order to save money. Be that as it may, there are strict rules in place on exactly what constitutes an exempt or non-exempt employee as well as what differentiates an employee from an independent contractor.

Misclassifying employees can carry substantial penalties and costly tax implications. The risks are real and ignorance of the rules will not excuse you. Read on to learn more about the differences regarding employee classification and when in doubt – contact an experienced corporate and employment law attorney to help designate members of your team and protect your business interests.

Exempt & Non-Exempt Employees – What’s the Difference?

Most jobs in the U.S. are governed by the Fair Labor Standards Act (FLSA) which establishes the minimum wage, overtime pay, and other employment standards. The FLSA also requires employers to classify positions as either exempt or nonexempt to determine whether or not the FLSA regulations apply. 

Non-Exempt Employees

As the term implies, non-exempt employees are not exempt from FLSA regulations. When an employee is classified as non-exempt, they must be paid at least the federal minimum hourly wage and be provided overtime pay no less than 1.5x their hourly wage for time worked above 40 hours each week.

Exempt Employees

Employees who are exempt from FLSA rules are excluded from minimum wage, overtime regulations, and other rights or protections given to non-exempt employees. Employers are required to pay workers a salary instead of an hourly wage for a position to be exempt. Generally, exempt positions are those that fall into executive, administrative, professional, or outside sales categories.

For most employees, their exempt or nonexempt status is contingent upon:

  1. How much they are paid.
  2. How they are paid.
  3. What kind of work they do.

Employees or Independent Contractors

An employer may pay an employee or independent contractor for similar work but there are crucial legal differences made between the two classifications. For employees, an employer will withhold income taxes, Social Security, and Medicare taxes. By contrast, an independent contractor must pay their own Social Security and Medicare taxes. In the U.S., independent contractors are considered sole proprietors or LLCs (single-member limited liability companies). They must report their own self-employment taxes and income among other expenses to the IRS.

The biggest impact for employers came down from the California Supreme Court who adopted a very expansive definition of “employee” in a recent case, Dynamex Operations West Inc. v. Superior Court. Under this new test, a worker is considered to be an independent contractor only if all three of the following ABC factors are present:

(A)  that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact;

(B)  that the worker performs work that is outside the usual course of the hiring entity’s business; and

(C)  that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Legal Concerns Regarding Employee Classification

Employer Tax Responsibilities

Because employers must pay taxes for employees but not for independent contractors, misclassification of workers can constitute tax evasion. Independent contractors must manage and self-report their own tax obligations and can result in tax underpayment if the worker does not comply or fully understand their responsibilities.

Labor Laws

All businesses must comply with state and federal labor laws. This includes minimum wage compensation and overtime tracking and payment. By comparison, independent contractors are not protected by most state and federal employment laws.

Tax Revenue

Worker misclassification is a serious detriment to state and federal governments. Improper classification denies government agencies of due tax revenue. By extension, this underfunds public services such as unemployment insurance and Medicare.

Fines & Penalties

When misclassification is considered unintentional, you could be charged:

  • 100% of the employer’s FICA contributions.
  • 40% of an employee’s Social Security and Medicare contributions.
  • 1.5% of the employee’s wages with interest.
  • Fees for each W-2 form not filed.

When misclassification is considered intentional, you could be charged:

  • Up to 1-year prison sentence.
  • Up to $1,000 in penalties for each misclassified worker.
  • 100% of the employer’s and employee’s FICA contributions.
  • 20% of all wages paid to the employee.

How Employers Can Reduce the Risk of Employee Misclassification

Misclassification of employee and independent contractors is a serious issue and must be treated as so. It is always a good idea to seek the counsel of an experienced corporate attorney to ensure you understand your legal obligations and mitigate the risks involved. For a review of your hiring practices and current employee status, please contact the trusted legal team at Bridge Law today!

Contact Us

We want you to feel comfortable discussing your legal issue with us. Contact us today to setup a time to come in and talk with our team.

 

Our Firm Locations

Head Office

Bridge Law LLP

155 N. Riverview Drive Suite 212,
Anaheim, CA 92808
Get Directions 714-525-2400

Contact Us Today

We want you to feel comfortable discussing your legal issue with us, so we offer a free consultation to learn about your problem. Contact us today to setup a time to come in and talk with our team.