The distinction between a 1099 independent contractor and a W-2 employee is an important one, as this classification affects federal income tax, social security and Medicare taxes, as well as impacts eligibility for Medicare benefits. It is critical that business owners correctly determine whether individuals are employees or independent contractors.
If a business misclassifies an employee as an independent contractor, the company could be liable for missing employment taxes, interest, and penalties and the employee may be entitled to past benefits. Additionally, a new report has been released that recommends even harsher penalties for worker misclassification.
Virginia Report on Misclassification and Payroll Fraud
A report was recently released, titled “Report for Executive order Thirty-Eight (EO38) From The Inter-Agency Taskforce On Misclassification And Payroll Fraud” which focused on the problems of employee misclassification in Virginia. The report claims that misclassification of employees as independent contractors “creates a competitive disadvantage for Virginia businesses that follow the law, deprives the Commonwealth of millions of dollars in tax revenues necessary to supply services to Virginia’s citizens, and prevents workers from receiving protections and benefits to which they legally are entitled.” According to a 2012 report, roughly one third of audited employers in certain industries are found to misclassify employees and this misclassification can lower Virginia’s income tax collections up to $28 million a year. About 1% of Virginia employers (approximately 2,000) are randomly audited each year and approximately 4,000 misclassified workers are identified.
Governor Northam issued Executive Order 38, which directed the Taskforce to produce its report. The Taskforce’s purpose was to: report on statutes and regulations related to worker misclassification and payroll fraud; make recommendations for changes to relevant statutes, regulations, and enforcement policies; and identify ways to address misconduct through incentives for compliance and meaningful penalties for non-compliance.
Based on the findings, the Taskforce made some recommendations, including: increase penalties for misclassification, so penalties are “substantial enough to deter misclassification;” enact legislation providing for a private cause of action against an employer for recovery of damages for misclassification; enact legislation providing “whistleblower protection” for those who report suspected misclassification or other workplace fraud; prohibit bidders from bidding on and receiving awards of contracts under the Virginia Public Procurement Act (VPPA) when the bidder is found to have violated requirements of proper worker classification.
This report should serve as a warning for all Virginia employers that the state is taking worker misclassification seriously and looking for ways to address the issue of misclassification. As the report recommends, these solutions may include harsher monetary penalties, inability for businesses to receive contracts under VPPA, and liability, through civil litigation, for employers who are found to misclassify workers. These new penalties, if enacted, could make worker misclassification very costly for employers. Virginia employers should aim to be fully informed of the differences between independent contractors and employees to ensure workers are properly classified. Below is a brief overview of the differences between independent contractors and employees, which may help employers decide whether or not their workers are properly classified (or find out more here).
Independent Contractor v. Employees
When determining whether a worker is an independent contractor or an employee, an individual’s label or position title is not determinative, and instead, it’s necessary to look at the totality of the relationship. There are generally three primary factors considered when determining if an individual is an independent contractor or an employee:
- Behavioral Control: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- If a company gives extensive instructions on how work should be done (such as how, when, and where to complete work), that indicates the worker is more likely an employee.
- If a worker receives extensive training or significant tools, materials, and other equipment from the company or has set hours of work, established by the company, the worker is more likely an employee.
- If work is performed on the premises of the company for whom the services are performed, the worker is likely an employee.
- Financial Control: Are the business aspects of the worker’s job controlled by the company?
- If a worker has a significant investment in his work or is able to realize a profit or incur a loss, he is more likely an independent contractor.
- If the worker is not reimbursed for some or all business expenses, he is more likely an independent contractor.
- Relationship of the Parties: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)?
- If a worker receives benefits, he is more likely an employee.
- If a contract exists, that might be an indication that the worker is more likely an independent contractor.
- If a company has a right to discharge the worker or the worker as the right to quit work at any time without incurring liability, he is likely an employee.
Generally, an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.
However, the factors listed above are not all-inclusive and other factors may be considered when determining the employment status of an individual. If you are unsure of the employment status of workers, attorneys at General Counsel PC can help you make an accurate determination and avoid facing penalties for misclassifications later. Our attorneys are specialized in labor and employment law and have experience working with business owners across Virginia. Call General Counsel PC at 703-293-5439 today to see how we can help you.