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Calculating the Cost of Employee Misclassification

An employer's failure to properly classify its workers as employees, rather than independent contractors, could result in liability for years of unpaid wages, insurance, benefits and employment taxes, in addition to penalty fees. Misclassification may also result in employers having to defend costly class-action litigation.

If you think your company may be misclassifying employees, you can calculate the potential cost of fines and penalties, using the following steps.

 If you’ve wrongly classified an employee as an independent contractor, the risk of getting caught is higher than ever, with state and federal governments collaborating to find offending employers and hold them accountable. All it takes is for an employee or contractor to file a complaint with either a state or federal labor agency.

If you think your company, or a company you know, may be misclassifying employees, you can calculate the potential cost of fines and penalties, using the following steps.

DESCRIPTION OF PENALTIES & FEES AMOUNT
1. W-2 Penalty: Number of misclassified employees x $50 for each Form W-2 that wasn't filed ____________
2. Wage Penalty: Estimated gross wages for all misclassified employees x 1.5% ____________
3. Social Security and Medicare Tax Penalty:  ____________
This penalty requires employers to pay 40% of the Social Security and Medicare (FICA) taxes the employee should have paid, plus 100% of the matching taxed the employer should have paid. ____________
a. Social Security Employee Portion: Total estimated gross wages for all misclassified employees x 6.2% ____________
b. Medicare (FICA) Employee Portion: Total estimated gross wages for all misclassified employees x 1.45% ____________
c. Social Security & Medicare Employer Portion: Total estimated gross wages for all misclassified employees x 7.65% ____________
Total (a) + Total (b) + Total (c) x 40%
Note: The cap on taxable wages for social security is $118,000, so the max Social Security employee portion is $118,000 x 6.2%= $7,316. This would apply below as well.
____________
 4. Failure to Pay Tax Range:  ____________
a. Low End of Range: Wage Penalty (total from 2 above) + Social Security and Medicare Tax Penalty (total from 3 above) x number of months the employees were misclassified x .5% ____________
b. High End of Range: Wage Penalty (total from 2 above) + Social Security and Medicare Tax Penalty (total from 3 above) x number of months the employees were misclassified x 25% ____________

 ESTIMATED TOTAL POTENTIAL PENALTIES (add totals from items 1 – 4 above)

____________


Note: If the IRS suspects fraud or intentional misconduct, you could be looking at additional fines and penalties – including as much as 20 percent of each worker’s wages and 100 percent of the FICA taxes (both employee’s and employer’s portions). There’s the possibility of criminal penalties and imprisonment as well.

The rules regarding whether a worker is an employee or an independent contractor are complex. To help you decide, download our free employee classification scorecard.

Free Employee Classification Scorecard