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If you think your business is too small for the government to care about, think again. Government agencies, like the IRS, the Department of Labor, and state agencies, have definitive standards on what constitutes an employee or a contractor, and mistakes can be costly. 

Here are five costs you may not expect that come with classifying someone as a 1099, when they should have been a W-2.

  1. Back taxes: at minimum, the IRS will calculate the taxes you should have been paying on your employee, including income (withholding) tax and Social Security, for up to three years back.
  2. Benefits: if the government believes you have failed to provide benefits such as overtime pay, unemployment insurance coverage, and health care, they will calculate what that adds up to and require you to reimburse the worker.
  3. Interest: Not only will you have to pay back taxes from the past months or years, you’ll likely be charged interest on them too.
  4. Fines: Everyone makes a mistake sometimes, and the government understands that. If they determine you unintentionally misclassified someone as a 1099, they may ask you to pay the back taxes and go on your way. However, if they believe that you willfully chose to classify someone as a 1099 when they should have been a W-2, you’ll likely receive a hefty fine in addition to the taxes you owe.  In addition, there may be fines for related compliance issues, such as failing to process an I-9 for your misclassified worker.
  5. Jail time: This one is extreme, but if the government determines that you have willfully misclassified worker(s), you could not only end up with a huge fine, you could land in jail.

Unfortunately, there’s a lot of misinformation on the internet, and there’s often the assumption that as a business owner, you have a choice of what works best for you. There are definitely legitimate reasons to have contractors on your team, but if the government feels that you’re calling people contractors when they should be employees, the costs can add up very quickly. 

Does this mean that you need to immediately need to switch all your contractors to employees? No. But we would suggest that you take the time for a little due diligence to check your compliance. 

If you find yourself in a grey area, one approach is to err on the side of caution and classify your team members as W-2 employees to mitigate your risks. It can be a challenge to make that change, but if you need help, give us a call or schedule a free consultation today.


*Note: Dunathan Consulting does not provide legal advice. This article is strictly informational in nature and should not be construed as legal advice. If you need a legal opinion on an employment issue, consult a qualified lawyer.