Employee Classification 101

When Barbara Business Owner started to hire for her growing business, she was not prepared for the complexities of her hiring options. Barbara was soon feeling a bit overwhelmed with the modern workforce of freelancers, part time, and remote workers all in addition to the traditional employee option.

As an astute business owner, Barbara was dedicated to doing her research around hiring the right fit for her company. She was also fortunate enough to have a networking colleague and good friend, Holly Human Resources. Holly’s career centers around this very topic and she is intimately familiar with the advantages and downsides of the different types of workers.

As Barbara was sharing her talent search over lunch, Holly confirmed that essentially there are two primary types of workers,  1099 or employee, and that workforce options mostly fall within these two groups, even when hiring through recruiters and staffing agencies.

“Both types of workers serve important roles in your business” Holly explained, “the important thing is to not misclassify the worker.”

“Mis-what?” Barbara asks, as she is not familiar with the term.

“Misclassification” Holly repeats. When Barbara gives her a blank look in return, Holly assures her that many business owners are not familiar with the term and continues with a crash course in worker classification.

Classification and Misclassification of Workers

In its simplest definition, worker classification refers to a worker’s status as either a W-2 employee or a 1099 independent contractor. Classification is defined at a regulatory level by various government agencies. These agencies have parameters around when a worker must be treated as an employee, and therefore be given certain rights and benefits, or can be hired and utilized as an independent contractor.

Employee classification refers to how workers are handled by the hiring company on factors like pay, taxes, benefits, and training according to federal, state, and local laws. All these factors are what regulatory agencies and HR professionals, like Holly, refer to as “employee compliance” or “independent contractor compliance.”

At the federal level, there are several agencies with their own sets of rules and regulations regarding employee classification and compliance, but the Internal Revenue Service (IRS) and the US Department of Labor (DOL) are the ones most employers will hear from when a violation occurs.

At the state and local levels, more regulations for worker classification may determine access to government benefits, and employers must ensure compliance. The state and local laws are in addition to the federal laws and are a breeding ground of complexity and confusion for most businesses.

Worker misclassification, Holly explains to Barbara, occurs when workers, who should be hired and managed as an employee, get hired as a 1099 contractor instead.

Most often, misclassification occurs because the business is not aware of labor laws or because they want to save the additional cost of employer taxes, required benefits, etc. However, the legal problems with worker misclassification are far more tedious and costly than ensuring compliance.

Repercussions of Misclassification

When government regulators suspect misclassification, they will conduct a classification audit. If employers are found to have misclassified workers the fines and penalties can be substantial. The business can incur back-pay costs and several fines from government agencies.

They may also be sued by the misclassified workers, which means they rack up legal fees, court costs, and settlement payments. Misclassification can also affect a business’s reputation negatively, and at the very least, they will incur administrative costs to reclassify those workers as employees.

The regulations around what qualifies a worker to be an employee are constantly evolving, Holly explains. That’s why she recommends a workforce partner for Barbara to navigate the maze of regulations regarding employee compliance.

Contact us today for a customized consultation about your workforce and available solutions.

ClearPath is a leading Human Resources Outsourcing company focusing on assisting employers to leverage the independent contractor labor market. We’re committed to helping business owners stay compliant and minimize the risks associated with their contingent labor requirements.

No Legal Advice Intended. This article includes general information about legal issues and developments in the law. Such materials are for informational purposes only and may not reflect the most current legal developments. These informational materials are not intended, and must not be taken, as legal advice on any particular set of facts or circumstances. You need to contact a lawyer licensed in your jurisdiction for advice on specific legal issues.