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In: Accounting

What are the tax consequences to an EMPLOYER of classifying a worker as an employee vs....

What are the tax consequences to an EMPLOYER of classifying a worker as an employee vs. an independent contractor?

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Tax consequences to an EMPLOYER of classifying a worker as an employee vs. an independent contractor

Classifying a worker as an employee or an independent contractor has a significant effect on the cost of employing that individual. Intentionally or not, many workers in the United States are classified as independent contractors (IC). In classifying a worker as an IC instead of an employee, employers can eliminate the following expenses:

  • The employer’s share of Social Security (FICA) and Medicare taxes
  • Overtime and minimum wage payments
  • Employee health insurance premiums
  • Employee retirement benefits, vacation, holiday, and sick pay
  • Other employee fringe benefits, such as stock options
  • Federal and state unemployment compensation taxes (FUTA and SUTA)
  • Workers’ compensation insurance premiums

For the independent contractor, the company does not withhold taxes. Employment and labor laws also do not apply to independent contractors.

Misclassification also causes federal, state, and local governments to suffer revenue losses as employers circumvent their tax obligations.Federal employment withholding taxes represent nearly 70% of all federal tax revenue to be paid to the IRS, which seeks back taxes and penalties from employers that wrongly treat workers as self-employed contractors.

Some civil penalities for misclassification of employee as an Independent contractor is given below:

  • Failure to file: 5% per month during the period of failure to file employment tax returns, up to a maximum of 25%.
  • Failure to make timely deposits of taxes: 10% if tax deposit is past due more than 15 days, and increases to 15% is not paid within 10 days of notice.
  • Under payment of tax: 20% of under payment of tax attributable to a substantial under statement of tax or negligence.
  • Willful failure to collect and pay tax: 100% of total tax not collected or paid.

Federal penalties for worker misclassification can be severe. Ramifications vary depending on whether the misclassification was unintentional, intentional, or even fraudulent.


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