Think Misclassifying Employees Will Save You Money on Work Comp Premiums? Think Again

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Misclassifying Employees
The 1800s was a difficult century for the American worker. Especially during the latter half, injured workers were often left without recourse after suffering a work-related injury or illness. To compound the problem, workers were often required to work 10 or more- hours per day, in dangerous conditions, and with inadequate breaks or rest periods.

The numbers were grim. By 1900, industrial accidents killed 35,000 people per year, and seriously injured 500,000 others. People who were injured usually received no compensation. Indeed, the first statewide workers’ compensation law was not passed until 1902, in Maryland. In the Federal system, government employees were first covered by a workers’ compensation program in 1906 via the Federal Employers Liability Act. By 1949, all states had enacted a workers’ compensation program.

Unfortunately, some employers are taking American workers back to the grim days of the 1800s. A rising epidemic of employee misclassification — employers wrongly classifying employees as independent contractors in order to save money on workers’ compensation premiums — leaves employees with increasingly fewer rights and protections in cases of job-related injury or illness. Misclassification also leaves employers open to harsh legal punishments.

Saving Money by Misclassifying Employees: A Huge Risk for Employers

Employers may consider misclassifying employees for three reasons:

1. U.S. employers are required to pay half of each employee’s Social Security and Medicare payroll taxes. Some employers misclassify employees as independent contractors to avoid these taxes, leaving the supposed independent contractors to pay the entire amount.
2. Classifying an employee as an independent contractor means employers don’t have to pay for medical benefits, retirement benefits, or worry about regulations such as the Family Medical Leave Act of 1993.
3. One of the major reasons employers misclassify employees is to avoid or play less in workers’ comp premiums. These premiums can significantly erode a company’s profit margin, and sometimes make the difference between having a profit or a loss. Premiums vary depending on the state, industry, size of the company, and loss history. Workers’ comp premiums are usually calculated as percent of a company’s annual payroll and/or based on the number and risk level of employees.

Employers who misclassify employees as independent contractors can reduce labor overhead by upwards of 30 percent. Independent contractor status is appropriate in many instances, but it is unlawful to classify workers as independent contractors and then exercise almost complete control over employees’ work situations. This wrongdoing creates an environment reminiscent of the terrible 1800s when employers often offered employees no benefits or support, and employees had no right to paid treatment or income benefits if injured.

Misclassification Damages Employees and Employers Alike

Workers’ compensation insurance is an employee benefit, and it is fundamentally wrong to misclassify employees as independent contractors. A misclassified employee injured on the job, may not receive the medical care or income replacement he would otherwise be entitled to. Instead, he will be on his own for an injury that should have resulted in a workers’ comp claim. In order to receive compensation, the employee would have to take legal action.

Employers should also note how misclassification can harm their businesses. Employers who misclassify are liable for back taxes plus various administrative penalties. This can add up a hefty number. The IRS can demand that an employer pay as much as 41.5 percent of a contractor’s wages in back taxes if found to be misclassifying workers. As for penalties: the IRS may fine a company $1,000 (and/or sentence the responsible parties to 1 year in jail) for “failure to properly classify and withhold wages.” If an employer is found guilty of “attempting to evade or defeat tax” — a felony — then penalties can include a $500,000 fine and/or five years in prison. Furthermore, employers may face significant ramifications at the state level.

In the end, employers who seek to cleverly save money by misclassifying employers are not so clever. When companies misclassify employees, they may be creating unsafe work environments, unfairly removing worker benefits and supports, and expose themselves to serious penalties that could put them out of business. It’s best for all involved to properly classify workers.

Tom Swiatek

As Assistant Vice President of Regulatory Services and General Counsel, Tom Swiatek draws on his experience as an insurance attorney on both the general liability side, as well as on workers’ compensation matters. As a Workers’ Compensation Section Member, Tom is leading the discussion with respect to the regulatory challenges and opportunities facing the workers’ compensation system.