If your business subject to an independent contractor/employee audit, either from the IRS or the Colorado Department of Labor (“CDOL”), one of the primary inquiries surrounds whether you have properly classified workers as employees or independent contractors. Generally, businesses are required to withhold and pay income taxes, Social Security, and Medicare taxes on wages paid to employees. But businesses generally do not have to withhold or pay taxes on payments to independent contractors. So by classifying an employee as an independent contractor, employers can avoid paying those taxes associated with regular employees. This misclassification of employees results in enormous sums of lost tax revenue for the government each year.
The IRS and Colorado have different standards for who is an employee versus an independent contractor.
The IRS definition of employment uses traditional common law employment rules. They determine whether a person providing services to a business is an employee by considering three categories of facts:
- Behavioral – What control does the business have over what the worker does and how the worker does his or her job?
- Financial – How is the worker paid? Are expenses reimbursed? Who provides the worker’s tools or supplies?
- Type of Relationship – Is there a written contract or employment agreement? Does the worker receive benefits? Is the work a key aspect of the business?
The IRS approach will look at the entire relationship, consider the extent to which the business controls the worker’s actions, and document each of the three categories to make a determination. In contrast, the Colorado definition of employment is much broader and goes beyond the common law rules used by the IRS. The two main concepts used to determine the status of workers under Colorado law are:
- Whether or not the worker is free from control and direction in the performance of the service, both under the contract for the performance of service and in fact; and
- Whether or not the individual is customarily engaged in an independent trade, occupation, profession, or business related to the service performed.
Like the IRS, the Colorado definition of an employee will consider the totality of the circumstances in making a determination as to the status of a worker. Under the Colorado rule, services performed by a worker are presumed to be employment. However, the existence of a written contract for services can negate this presumption if the contract contains specific clauses that both parties agree to. Those clauses can be found here.
A business operating in Colorado must be aware of the differences in employee classification standards. Even if your business properly classifies a worker as independent contractor under the IRS standard, you may still be liable for misclassification of the employee under the Colorado standard. The attorneys at Robinson & Henry have years of experience in tax and labor matters. We will be able to review the facts surrounding the hiring of workers by your business and can advise as to whether a worker is likely to be an employee or an independent contractor.
The misclassification of employees can lead to serious problems for an employer
Per the Colorado Employment Security Act , the misclassification of workers as independent contractors and not employees may pose a significant problem and leads to underpayment of employment taxes and premiums that employers are obligated to pay the state for covered employment. Because of the tax benefits to employers when they classify workers as independent contractors, many employers may be tempted to misclassify. It is very important that you do not make this mistake with your business.
If the IRS finds that your business has misclassified employees, you may be held liable for employment taxes that should have been withheld plus interest and may also be subject to penalties.
In Colorado, any person may file a written complaint with the CDOL alleging that an employer has misclassified a worker as an independent contractor. After a complaint is received and the CDOl determines that an investigation is needed, the appropriate parties will be notified. If the investigation finds that an employer has misclassified employees, the employer must pay all back unemployment insurance premiums owed with interest.
If the investigation determines that an employer has misclassified employees with willful disregard of the law, the employer may be fined up to $5,000 per misclassified employee for the first misclassification and up to $25,000 per misclassified employee for a second or subsequent misclassifications. In addition, upon a second or subsequent misclassification, the employer is prohibited from contracting with, or receiving any funds from, the state of Colorado for up to two years.
If you are a worker and have been misclassified as an independent contractor by your employer, it can be costly.
When an employer classifies workers as independent contractors and saves money, those costs are effectively passed on to the workers. A worker classified as an independent contractor is:
- Required to pay all of his or her Social Security and Medicare taxes out of pocket. While employers must pay half of these taxes for employees, they are not required to do so for independent contractors.
- Ineligible for unemployment benefits and your employer won’t have to pay UI premiums for you.
- Ineligible for worker’s compensation benefits and your employer won’t have to pay for workers’ compensation insurance for you.
- Ineligible for workplace rights that employees generally have, such as a minimum wage, overtime pay, or sick pay.
- Ineligible for healthcare coverage as an employee under Obamacare.
If you believe that you have been mistakenly or willfully misclassified as an independent contractor, you should first try talking to your employer to understand why you have been classified that way. If your employer is unresponsive or does not cooperate, you can try contacting the IRS or the state department of labor. If neither of these options results in changing your employment classification, the attorneys at Robinson & Henry can help. Often times, a formal demand from an attorney will cause the employer to correct the misclassification.
Call Robinson & Henry Today for a Initial Assessment
The experienced business and tax attorneys at Robinson & Henry are well prepared to assist you with any employee classification concerns. We can help you minimize your business’s liability, properly determine the classification of a worker, or help to defend your business’s classification before a CDOL employee audit.
Call us at 303-688-0944 for a initial assessment to discuss employee misclassification or any other business challenges. We are eager to provide answers to your legal questions and help you successfully accomplish your business objectives.