Workers are generally classified as either independent contractors or employees. The distinction can be confusing, and when a business gets it wrong, it can have negative legal consequences. Several governmental agencies may be able to impose fines, sanctions, and other unpleasant penalties. For this reason, it is extremely important to have competent legal counsel who can help you classify your workers correctly.
Employment Development Department (EDD)
The EDD’s major concern is that employers classify workers as independent contractors when they should really be considered employees. After the EDD investigates an employer and determines that misclassification has occurred, it will send the employer a “Notice of Assessment.” This notice will explain how the employer should begin to report its employees for state payroll taxes.
Misclassifying employees is a form of payroll tax fraud and is a crime in California. It is a misdemeanor that can result in a penalty of up to $1,000, a sentence of up to one year in jail, or both.
Penalties and late fees for tax payments can be imposed as well. The penalty is often 10% on the unpaid taxes, with interest.
The Labor Commissioner of the California Labor and Workforce Development Agency
Employers that intentionally misclassify workers to avoid paying taxes and benefits are subject to investigation and prosecution before the Labor Commissioner. Fines are between $5,000 and $15,000 per violation. If there is a pattern and practice of misclassification, the fines may be increased to between $10,000 and $25,000 per violation.
The Labor Commissioner will have a hearing to determine if misclassification has occurred and to impose penalties.
Internal Revenue Service
There also can be federal tax consequences of misclassification of workers in addition to state payroll tax penalties. The penalty for failure to withhold federal income tax is 1.5% of the wages paid. The form can be doubled if the employer also did not file a Form 1099 with the IRS. The penalties for unintentional failure to withhold Social Security and Medicare is 20% of the employee’s share of the tax. Again, that fine doubles if the employer does not file a Form 1099.
If the misclassification was intentional, then the employer is liable for the full amount of the tax that the employee would have otherwise had to pay. This includes the employee’s share of Social Security and Medicare taxes as well.
One of the state agencies is far more likely to investigate a misclassification claim compared to the IRS. However, the state agency will usually notify the IRS of a misclassification finding so that the IRS can impose penalties as necessary.
Getting Legal Help
There is a lot at stake in classifying employees correctly. If you are unsure of your classification or if an agency has notified you that your business is under investigation, it is a good idea to have an experienced employment law attorney on your side. Call (925) 399-1529 to set up an appointment.
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