June 21, 2019

blankEmployers must correctly label their workers as employees or independent contractors. Employees have certain legal benefits from employers, such as withholding taxes (Social Security), unemployment insurance, and workers’ compensation insurance. By contrast, independent contractors do not have these benefits and must pay for these themselves. In general, companies that hire independent contractors tend to reduce their labor costs.

Misclassification of workers as independent contractors carries heavy penalties under state and federal laws. If you are an employer in Colorado, you must be aware of the rules that apply regarding worker misclassification.

Differences Between Employee And Independent Contractor

For an employer to legally label a worker as an independent contractor, the working relationship should satisfy the state and federal definitions of an independent contractor (IC).

Under the Colorado Employment Security Act (CESA), an IC is a worker who “is free from control and direction in the performance of the service” and “is customarily engaged in an independent trade”. The CESA has nine specific factors to establish an independent contractor relationship (found here). If a worker cannot be shown to be an independent contractor, they are presumed to be an employee.

The US Internal Revenue Service (IRS) has a general definition of an independent contractor relationship. It is when “the payer [employer] 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.” To determine the worker classification of an individual, the IRS will look at the specific facts of the case and ‘test’ them to see if they fit the definition.

Similarly, the US Department of Labor (DOL), under the Fair Labor Standards Act (FLSA), has a broad approach to this. It will look at “‘economic reality’ rather than ‘technical concepts’” to determine whether a person is an employee or an independent contractor.

Colorado State Penalties For Worker Misclassification

In 2009, Colorado enacted the Misclassification of Employees as Independent Contractors Act, which imposes stricter penalties on violating employers. Under this law, workers may file a confidential complaint with the Colorado Department of Labor and Employment’s Division of Employment and Training. If the Division decides that the complaint warrants an investigation, the employer will be required to cooperate.

Here are the penalties for misclassifying an employee in Colorado:

  • Paying all back unemployment insurance premiums owed, plus interest
  • If employer had willful disregard of the law (first offense), they may be fined up to $5,000 per misclassified employee.
  • If employer had a subsequent misclassification with willful disregard of the law, they may be fined up to $25,000 per misclassified employee. They will also be prohibited from receiving funds or contracting with the state for up to two years.

Federal Penalties For Worker Misclassification

Federal consequences from the IRS or the DOL are more severe. The IRS deals with the tax-related aspects of employee misclassification, while the DOL enforces labor laws, primarily the FLSA. These agencies may impose separate penalties, and much of these depend on whether they find the classification unintentional, intentional (willful), or fraudulent.

For example, these are some of the civil penalties that the IRS may impose on unintentional misclassification:

  • Failure to correctly provide payee statements: $50 for each Form W-2 and 1099 that the employer did not furnish
  • Failure to file employment tax returns: 5 percent per month of not filing, up to a maximum of 25 percent
  • Civil fraud: 75 percent of the underpayment due to fraud.

If the IRS finds that an employer willfully misclassified a worker, that employer may have to pay 100 percent of the related FICA taxes (whereas in normal cases, the employer and employee share this cost).

There are also potential criminal penalties for willful or fraudulent misclassification. These include a fine of up to $10,000 and imprisonment of up to five years for failure to collect or pay tax.

DOL penalties for employee misclassification include:

  • Back wages of up to three years (for compensation not previously given, such as overtime rates or minimum wage)
  • Back taxes of up to three years
  • Back unemployment insurance premiums
  • Back workers’ compensation insurance premiums.

Unintentional misclassification of employees is also punishable. As an employer, you need to make sure that your working relationships are declared correctly according to laws. It is best to consult with a business attorney in your state. A competent lawyer can also protect your business if it is being audited or investigated by government entities.

We at Goldman Law are prepared to advise you and help ensure that your employment is thoroughly compliant with state and federal rules.

Categories: Worker Misclassification