Misclassifying Employees May Be Costing You More Than You Think
by Christina Thompson-St. Clair, Vice President of Sales
Properly classifying workers is one of the most important and riskiest aspects of operating a business. Employee versus independent contractor. This may seem like a simple distinction, but getting it wrong can lead to major financial and legal headaches.
We work with countless small and mid-sized businesses who don’t realize just how costly misclassification can be until it’s too late.
Why Classification Matters
Classifying someone as an independent contractor when they should be an employee might seem harmless, especially if that’s what both parties want. Contractors don’t require tax withholdings, benefits, or unemployment insurance. But the IRS and state agencies see it differently.
If your business is audited and workers are found to be misclassified, the potential consequences may include:
- Back taxes and penalties.
- Unpaid overtime or minimum wage violations.
- Unemployment insurance claims.
- Legal action from misclassified workers.
- Damage to your organization’s reputation.
The Gray Area Isn’t So Gray
Many employers think they can rely on job titles or working arrangements to make the decision. But classification is based on how the work is performed, not what it’s called.
The IRS uses three main criteria to determine status:
- Behavioral Control – Do you control how and when the work is done?
- Financial Control – Are you providing tools, reimbursing expenses, or dictating pricing?
- Relationship Type – Are there benefits, ongoing work, or the expectation of permanence?
If the answer is “yes” to many of the above, you’re likely looking at an employee classification, not a contractor.
What’s the Real Cost?
As an example, your organization has classified five people as contractors over the last two years. After an audit, they’re reclassified as employees. Now your business owes:
- FICA taxes (employer and employee share).
- Federal and state unemployment taxes.
- Possible back pay for overtime.
- Penalties and interest.
Even if you’re a small business, that bill can easily amount to thousands of dollars.
How Payroll Services Help
At Payentry, we do more than process payroll. We help you stay compliant proactively.
We work closely with clients to:
- Review worker classifications.
- Automate tax filings and reporting.
- Stay on top of ever-changing labor laws.
- Provide documentation and audit support if needed.
Don’t Wait Until It’s Too Late
Misclassification can sneak up on even the most well-meaning employers. A contractor today could be considered an employee in the eyes of the law tomorrow, especially if your business model evolves. If you’re unsure about your classifications, there are options. Our HR Services team is here to help you get it right. Contact us today to learn how our HR and payroll services can support your business.
Payentry personnel management professionals provide expert support in payroll, workforce management, human resources, benefits administration, and retirement planning services.
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* MPAY LLC dba Payentry (Company), is not a law firm. This article is intended for informational purposes only and should not be relied upon in reaching a conclusion in a particular area of law. Applicability of the legal principles discussed may differ substantially in individual situations. Receipt of this or any other Company materials does not create an attorney-client relationship. The Company is not responsible for any inadvertent errors that may occur in the publishing process.
