Some of the legal consequences
Upon further research, I would like to add more about the legal ramifications of miss-classification. Other answers have done a good job of what makes an employee an employee and what makes them a contractor. I want to address the legal consequences of doing it wrong.
Misclassification penalties depend on several factors including the size of the company, the amount of time the misclassification was in effect, and whether the Department of Labour considers the incorrect classification to have been intentional.
Tax Violation Fines:If the IRS conducts an audit and finds a miss classification the business could face fines including
- Up to 3% of the employee's wages
- 100% of the FICA taxes not paid
- Up to 40% of back taxes
- 50% per W-2 tax form that was not filed wages.
Misclassification also violates employee's federal protections regarding minimum wage and benefits. The Department of Labour takes these issues very seriously. At a minimum back wages may be paid but criminal penalties can also be imposed, which may include.
- Payment penalties of up to a 1000$ per employee
- Jail time of up to 1 year
- Class Action Lawsuits
- Benefits insurance repayments
- Additional audits looking for other irregularities
