7 Warning Signs - Subcontractors vs. Employees

As a business owner, properly classifying workers as independent contractors or employees is crucial. Misclassifying an employee as a subcontractor can lead to steep fines, back taxes, lawsuits and other penalties down the road. Heed the following warnings around subcontractors vs employees designation.

Warning #1 - Workers Compensation Claim

If you classify an employee as a contractor, you lose the exclusive remedy protection that caps employer liability under workers’ comp statutes. For employees injured on the job, state-mandated workers’ compensation insurance typically covers medical bills and lost wages, preventing lawsuits against the business.

However, contractors can file civil lawsuits against you. Without the liability shield, you could be sued for negligence and face pricey legal fees, settlements and judgments. If a misclassified employee gets injured, you lose statutory immunity and could owe comp benefits plus substantial tort damages.

Warning #2 - Unemployment Claim

When contractors provide services for your business, they're not eligible for unemployment benefits if that working relationship ends. However, misclassifying true employees as contractors means you haven't paid unemployment taxes as required.

If a worker you designated as a contractor files for unemployment, the state may rule they should have been classified as an employee. You could then be hit with penalties for not paying unemployment premiums. Worse, once they investigate, expect steep interest and fines on unpaid back taxes for all misclassified workers.

Warning #3 - Workforce Services Overtime Claim

Exempt salaried employees aren't entitled to overtime under the Fair Labor Standards Act or state wage/hour statutes. But if you incorrectly treat hourly employees as exempt based on their contractor label, that jeopardizes your overtime exemption defense.

In an audit or lawsuit, you would struggle to prove contractors were rightly classified as exempt employees, resulting in overtime and minimum wage violations. The damages can tally quickly between unpaid OT, interest, attorney fees and liquidated damages.

Warning #4 - ERISA and Retirement Discrimination

While not all contractors receive benefits, as employees, they're legally entitled to tax-qualified retirement and group health plans unless specifically exempted. If designated employees don't get access to your ERISA plan due to misclassification, it violates discrimination rules under federal law.

Essentially, to deny qualified benefits plans to groups of employees opens the door for litigation. Failing non-discrimination tests leads to steep excise taxes and penalties, along with massive headaches to correct.

Warning #5 - Federal Payroll Tax Audit

Perhaps the greatest liability risk with misclassifying employees is unpaid federal payroll taxes. Audit exposure goes back three years for FICA, FUTA and income tax withholding mistakes. The bill can climb into six figures rapidly when you factor in interest, penalties and multi-year obligations.

With contractor classifications, you may have skipped required tax withholdings, leading to substantial IRS assessments down the road plus penalties up to 30% if deficiencies deemed intentional. Payroll taxes are nothing to trifle with.

Warning #6 - Partnership Claim

If significant control is exerted over a contractor’s duties, hours, and means of work, they could petition to establish a legal partnership with you. This implies you would split profits proportionally with the contractor based on their ownership interest.

Worse for you, it makes the business jointly liable for any contractual breaches, debts, lawsuits or other liability incurred by the contractor. Relinquishing control guards against involuntary partnership rights for a contractor.

Warning #7 – Third-Party Injury/Damage

Under vicarious liability statutes, employers bear responsibility for employees’ negligence during business activities that hurt another party. However, independent contractors act outside such responsibility.

So, if a worker identified as an contractor causes harm or property damage, and allegations arise about employment misclassification, you could still be on the hook. The door opens to damaging litigation.

These warnings reveal just some of the legal, tax and other compliance traps that snare employers classifying workers incorrectly. Get support to ensure proper designation, documentation and treatment when engaging contractors to avoid these substantial risks. Being proactive on compliance is wise.

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