Misclassification Of Employees Can Be Expensive

Like most business owners, I am always looking for ways to cut costs and increase profits.  One way that is often used is to treat workers as “independent contractors” rather than “employees”.  That’s a good strategy if you get it right.  But if you aren’t very careful, this approach can end up being far more expensive in the long run.

The consequences of misclassification may include having to pay payroll taxes that should have been withheld from employees plus federal and state unemployment on those wages.  But the greater risk is the penalties and fines that state and federal Labor Departments can levy.  The penalties and fines can be substantial enough to put any company out of business.  In New Hampshire, a single violation can lead to a $2,500 fine plus $100 per employee per day for noncompliance, for as far back as a year.  So, yes, do the math.  $36,500 per employee plus $2,500.  You may not live or work in New Hampshire, but your state probably has something comparable.

I was recently made aware of a Labor Department case where the department insisted that a non-working spouse was an employee of her husband’s sole proprietorship simply because she assisted him with the business (for no pay).  Seems innocuous enough, until you consider record keeping requirements, employment taxes, and worker’s compensation insurance.

The IRS has established a 20 factor test to help determine the employment status of workers.  These factors are broad, and I can often find arguments to support either position:  that the worker is or is not an employee.

However, the State of New Hampshire has established a three factor test which makes it very difficult to have independent contractors working in or for your business.

NH RSA 282-A:9 defines employment in the State.  Here is the legal language:

III. Services performed by an individual for wages shall be deemed to be employment subject to this chapter unless and until it is shown to the satisfaction of the commissioner of the department of employment security that:
(a) Such individual has been and will continue to be free from control or direction over the performance of such services, both under his contract of service and in fact; and
(b) Such service is either outside the usual course of the business for which such service is performed or that such service is performed outside of all the places of business of the enterprise for which such service is performed; and
(c) Such individual is customarily engaged in an independently established trade, occupation, profession, or business.

Notice that you have to pass all three tests; failure on any one factor means the worker is an employee.  In my experience, the hardest one to pass is the second one:  the worker is doing something for you that is outside your normal course of business or away from any of your places of business.  Say, for example, if your business is painting houses and you have someone working with you to paint houses, that person is probably an employee.  If you are a landscaper with a crew working for you, those workers  are probably employees, even if they are part-time, temporary, or seasonal.

And I am finding that both the NH Department of Employment Security and the NH Department of Labor are becoming much more aggressive in enforcing these standards.

If this article raises concerns for you about your classification of workers, then we need to talk … SOON!  Please call me before the auditors show up at your door.