Worker misclassification poses serious risks for businesses.

• Author: Wiletsky, Mark

Colorado, along with many other states and the federal government, is cracking down on businesses that misclassify workers as independent contractors. An independent contractor, or consultant, is a non-employee. They are not subject to payroll tax withholdings, nor are they eligible for other benefits typically afforded to employees. For example, they are not eligible for and do not receive: workers' compensation and unemployment insurance (unless provided by another entity); health, medical, or retirement benefits; vacation, sick leave, or family/medical leave; overtime; or protections against discrimination and retaliation under Title VII and other federal anti-discrimination statutes. They also are not eligible to join a union. Thus, contractors often provide a cheaper alternative to hiring individuals as employees. But not everyone qualifies for contractor status, and misclassification impacts government revenue.

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The General Accounting Office estimates independent contractor misclassification costs federal revenues $2.72 billion annually. With significant shortfalls facing federal and state governments, it is no wonder they are making misclassification a priority. The 2011 federal budget authorizes $25 million to the United States Department of Labor (DOL) to target employee misclassification, the DOL will hire 90 new wage and hour investigators and 10 additional lawyers to just target worker misclassification, and the Internal Revenue Service will randomly audit 6,000 businesses over the next three years. Because so many individuals are misclassified, the increased enforcement will likely have a significant impact on a variety of industries.

The penalties for misclassifying someone as a contractor can be severe. Under a new Colorado law, businesses may be fined up to $5,000 per misclassified employee for a willful violation. If another willful violation occurs, the penalty jumps to $25,000. In addition to these potential penalties, businesses that have misclassified individuals as contractors may be liable for failing to withhold and pay the employer's share of taxes, failing to pay unemployment or workers' compensation insurance, overtime violations, and benefit plan disqualification, to name only a few.

Companies may also face penalties for failing to collect immigration-related documents to ensure that contractors are legally authorized to work in the United States. And if individuals who were once classified...