Compliance Alert: Maryland’s New Sanctions for Misclassifying Independent Contractors [Blog Post]
October 25, 2016
The following SC&H Group blog post discusses the newly passed sanctions on employee misclassification, helping executives to determine their independent contractors and properly meet all reporting requirements.
In recent years, the misclassification of employees as independent contractors has become a growing issue. In fact, a recent Treasury Inspector General for Tax Administration (TIGTA) report found that an estimated 3.4 million employees are classified as independent contractors when they should be reported as employees—costing the U.S. an estimated $54 billion in underpayment of employment taxes.
In response, the U.S. Department of Labor has partnered with the IRS and 35 states to ensure workers get their entitled wages, benefits, and protections. These measures are taking shape in various ways, including through information sharing and coordinated enforcement. Such is the case in Maryland.
Effective October 1, 2016, the Maryland General Assembly passed new sanctions on employers who misclassify workers. Among many effects, these sanctions will increase interest on overdue contributions and raise penalties for knowledgeable misclassification. Therefore, to ensure that organizations comply with these regulations, they should complete four key tasks:
1. Properly determine independent contractors
2. Understand Maryland’s penalties for misclassification
3. Understand additional potential federal consequences of misclassification
4. Properly file for independent contractors
1. Determining Your Independent Contractors
By law, all workers are employees unless they meet a test for independent contractor status. Status is determined by the relationship of the parties, not independent contractor agreements. For instance, independent contractors must be in business for themselves and actively manage and promote their business.
The Maryland Independent Contractor test uses the following three qualifications to evaluate whether an individual is an independent contractor.
- The individual who performs the work is free from control and direction over its performance both in fact and under contract.
- The individual is customarily engaged in an independent business or occupation of the same nature as that involved in the work.
- The work is outside of the usual course of business of the person for whom the work is performed, or performed outside on any place of business of the person for whom the work is performed.
2. Understanding Maryland’s Penalties for Misclassification
If it is determined that a worker should be classified as an employee and not an independent contractor, the employer may face wage and hour taxes, liability for payment of unemployment workers compensation benefits, and liability under other laws that provide benefits to employees.
Employers that misclassify independent contractors may be ordered to pay unemployment contributions. And as a result of the new sanctions, employers will now also be assessed 2 percent interest if those contributions are not paid in full within 45 days of the order to make payment.
Further, if determined by the Maryland Secretary of Labor, Licensing and Regulation to have knowingly misclassified, employers will see the following penalties:
- $5,000 per employee penalty for employers who knowingly misclassified workers as independent contractors
- $10,000 per employee penalty for subsequent violations
- $20,000 penalty for person(s) (attorneys, accountants, HR) who knowingly advised employers to misclassify
Moreover, misclassification determinations may also be reported to the Worker’s Compensation Commission, Insurance Administration, Division of Labor and Industry, and Comptroller.
3. Understanding Potential Federal Consequences of Misclassification
Since Maryland’s regulations are part of a nationwide effort, employers that misclassify workers could face additional consequences from federal agencies.
For instance, the IRS created the Determination of Worker Status Program (SS-8 Program), allowing businesses and workers to request determination letters regarding a worker’s Federal employment tax status as an employee or independent contractor. Although the SS-8 Program itself has little ability to enforce compliance after a determination ruling is made, the IRS’s audit referral and audit classification process helps enforce these rulings.
Each year, the SS-8 Program refers approximately 9.5 percent of worker determinations to operating divisions for audit consideration, according to the TIGTA report. Also, the percentage of referrals resulting in an audit doubled in the three years after the division refined its referral criteria and standardized its classifications, going from 38 percent in FY 2008 to 85 percent in FY 2011.
4. Properly Filing for Independent Contractors
To avoid potential penalties, organizations should partner with an established accounting firm that can provide sound guidance and help mitigate risk.
By engaging a firm that provides due diligence, tax planning, compliance, audit, and consulting services, organizations can ensure that they have correctly identified independent contractors versus employees, filed the appropriate taxes, met all reporting requirements, and prepared for potential audits.
Want to learn more about misclassification and how to determine which employees are independent contractors? Or, do you need assistance with proper tax and audit planning and compliance? Contact SC&H Group here.