The Dangers of Employee Misclassification



It's estimated that the federal government loses $3-4 billion in revenue a year because employers label their full-time workers as independent contractors. Then there’s the ones that pay their workers under the table.Since so many continue to cut corners this way, there’s no real way to know how much money is lost annually.

When running a business, it’s important to recognize the dangers of employee misclassification, and know what qualifies under this category and why. An an employer, one should understand the consequences that come with wrongly classifying an employee as an independent contractor.

With an estimated 3.4 million employees wrongly classified as independent contractors in the U.S. alone, this is what you need to know.

Why Employers Continue to Misclassify Their Employees

The biggest reason why employees are misclassified is because employers feel that they are saving money this way. When someone is an independent contractor, that means that their flat fee isn’t taxed.

What does this mean? In short, independent contractors aren’t required to receive any sort of benefits. That means there’s no overtime, retirement options or general care this way. Independent contractors have to foot their own money in order to get benefits.

Other reasons why employees are misclassified include:

  • Avoiding Medicare and Social Security taxes.
  • Avoiding vacation, holiday and sick pay.
  • Avoiding unemployment compensation taxes.
  • Avoiding Workers’ Compensation insurance costs.

If an employer wrongly classifies an employee, these are most likely the reasons why. However, doing this has major downsides.

How Employee Misclassification is Detrimental to a Business

Employers often get caught in this problem when an employee gets hurt and needs additional coverage to recover. Once the Department of Labor (DOL) and the Internal Service Revenue (IRS) is involved, they’ll take the time to figure out whether the misclassification was accidental or intentional. Some consequences that will be faced include (in the case of an accidental misclassification):

  • $50 for each W-2 form that was failed to be filed.
  • Penalties such as 1.5 percent of wages, 40 percent for Social Security and Medicare taxes and 100 percent of the matching taxes required from the employer (commonly labeled as FICA). There’s also going to be interest tacked onto the fees that weren’t paid.
  • A Failure to Pay Taxes penalty equating to 0.5 percent tax liability, with a max of 25 percent total tax liability.

If the IRS suspects some kind of fraud, the penalties are more severe; in short, expect additional penalties and fines. Employers can be subject to paying up to 20 percent of the wages paid to the employee, as well as 100 percent of FICA taxes on both ends. There’s also criminal fines of up to $1,000 per misclassified worker, as well as paying for whatever taxes were withheld.

Management Liability Policy Protection is Essential For a Business

If you’re a business owner trying to protect your business, having management liability insurance is going to be vital. There’s insurance policies available that can protect a business from defense costs relating to wage-and-hour claims. Carefully reviewing your policies ensure that you know the ins and outs of protecting your business from employee misclassification mishaps.



About Axis Insurance

At Axis Insurance Services, we aim to help our customers identify their exposures and protect themselves. Founded in 1999, we offer insurance programs to a wide variety of professionals and industries including attorneys, real estate, healthcare, architects, and more, and also have a wholesale division. We pride ourselves on offering flexible insurance coverage tailored specifically to each customer’s needs. To learn more about our solutions, contact us at (201) 847-9175 to speak with one of our professionals.

contractor, management liability, management liability insurance, Employee Misclassification, Contractor Misclassification

Recent Posts


See all