Posted On August 24, 2020
Worker Misclassification Can Trigger an Audit

Worker Misclassification Can Trigger an Audit

Misclassifying workers as 1099 independent contractors instead of W-2 employees can trigger an audit with the Internal Revenue Service. This is a major red flag that the IRS looks for and has made a priority to investigate. Additional consequences of work misclassification could include being found guilty of breaking employment laws.

Multiple Reasons an Audit Might Be Triggered

Companies could be flagged by the IRS for an audit for one or more reasons, including:

  • A 1099 independent contractor files a claim for unemployment benefits even though not eligible for unemployment.
  • The independent contractor files a claim for disability or worker’s compensation benefits instead of carrying their own workers’ compensation.
  • The employee receives both a 1099 and W-2 form in the same year from the same employer because they converted from an independent contractor to a direct hire.
  • The worker believes they are incorrectly treated as a 1099 independent contractor and files a complaint with the Department of Labor.
  • The employee files a Form SS-8 with the IRS or Form 8919 Uncollected Social Security Tax and Medicare Tax on Wages with their income tax return.
  • Someone has anonymously alerted the IRS that the employer or worker is not paying taxes.

Determining if a Worker is a Common Law Employee

In 1987, the IRS published a 20-factor test to help employers and workers determine whether a worker is an independent contractor or a common law employee. The IRS restructured the test in 1996 to have three main categories: financial control, behavioral control, and type of relationship.

The key factor used to determine whether a worker should be classified as a 1099 independent contractor or W-2 employee is the amount of control the employer has over its workers. The more control an employer has, the more likely the worker will be considered as an employee instead of an independent contractor.

Consequences of Misclassifying Workers

Employers that are found guilty of misclassifying workers as 1099 independent contractors will be subject to taxes owed and other penalties. Since the IRS communicates with state agencies, if it is determined that labor laws have been violated, they will be required to pay any back wages, back taxes, unemployment premiums, and workers’ compensation premiums. There is a potential for severe penalties, depending on what labor laws are violated.