Typical Consequences for Misclassifying Independent Contractors

Over the years, we’ve had a unique opportunity as an independent contractor law-focused law firm to get insight into the actual/practical consequences of misclassifying workers as independent contractors.

For some contractor misclassifications, the consequences can be relatively minor, i.e., a few hundred or a few thousand dollars in fines to agencies, and a stern talking to. For others, the consequences can be devastating, i.e., hundreds of thousands of dollars in fines, along with a doubling of assessed fines in the case of repeat offenders. In more rare cases, we’ve seen clients with fines approaching or exceeding a million dollars. And in one case involving a contractor death in the workplace, a client was made to cover several hundred thousand dollars in death benefits paid to the spouse of a deceased misclassified worker. Most cases that come to us fall somewhere in between.

While consequences for misclassification can span a wide range, below is our attempt to share what we’ve seen over the years as the typical consequences — based on a business’s risk profile — resulting from findings that a business misclassified independent contractors.

Scenario 1 – Low Risk

(Typically fewer than 10 workers, low risk of injury profession, e.g., office environment)

When misclassification occurs at businesses that misclassify only a few workers and in professions with a low risk of workplace injury, the consequences for misclassification can be fairly minor (barring complicating factors).  The reasons for the low risk are as follows:

  • If you were audited by Washington State Department of Labor & Industries (L&I), and you were found to be working with misclassified contractors, you would end up owing a minimal amount of workers’ comp premiums because premiums charged on low-risk professions are minimal, i.e., a few cents per hour worked. And if you have only a few misclassified workers, those premiums don’t tend to add up. [Caveat: an audit triggered by a significant workplace injury could result in you being stuck with medical costs and lost wages, which can add up to substantial amounts]
  • If you were audited by Washington State Employment Security Department (ESD), if you hired only a few workers who aren’t highly compensated, then the risk of a large assessment would also be minimal since ESD assessments increase based on number of workers misclassified and the amount of wages paid.
  • Audits by the Internal Revenue Service (IRS) are less common (though they obviously can happen), but given the frequency of IRS audits, it’s not something to be overly concerned about particularly if your L&I and ESD risks are low.

To be clear, low risk as used here means low financial consequences, and is not intended to suggest that any level of noncompliance is okay or recommended. Compliance, regardless of the risk level, is always important and advised.

Typical financial consequences: In low-risk scenarios, tangling with a government agency in a well-managed audit would usually end up costing a business something in the range of $500-$5000 in fines as a good result; and $5000 to $10,000 as a worst-case result.  For these businesses, an audit is not the worst thing, though changing course is critical since fines become significantly more punitive for repeat offenders.

Scenario 2 – Moderate-to-Significant Risk

(Typically 20-40 workers, 3-year audit period, moderate risk of injury profession e.g. construction trades)

The more workers a business has, the more its compliance risks increase via agency audits; and the more likely it is for claims to be initiated by the workers themselves. Reasons for the moderate-to-significant risks are as follows:

  • If you were audited by L&I, you would end up owing a moderate to significant amount of workers’ comp premiums if your business environment involves a moderate risk of injury and if you’re working with a lot of misclassified workers. Factors that further increase L&I risk include:
    • Increased chance of serious worker injury due to the number of workers
    • Disgruntled misclassified workers initiating claims (i.e. nobody seems to know independent contractor law better than a disgruntled misclassified worker)
    • Business competitors and clients complaining to L&I about misclassification (L&I has to investigate all misclassification complaints, so each complaint against your business can be consequential)
    • The larger your business the more likely it is that you’ll cross paths with L&I, or that an L&I inspector will show up at one of your work places/job sites.
  • If you were audited by ESD, your risks would stem from the following:
    • Unemployment premiums are owed based on wages. So the larger the company, the more wages paid, and therefore the more premiums owed.
    • Increased instances of workers filing for unemployment, thereby triggering audits. Indeed, during the Covid-19 pandemic or shortly after, many of you experienced contractors filing for benefits, triggering audit letters to you from ESD.
    • The larger your business the more likely it is that you’ll cross paths with ESD
  • Again, audits by the IRS are less common, but if they do your assessments are likely to be significant given the various federal employment taxes that would be owing.
  • The more revenue your business generates, the more agencies will assume that you have employees (i.e. agencies see it as a red flag if you’re reporting a million in revenue and no employees, or $5 million in revenue and two employees, etc.).

Typical financial consequences: In moderate-risk scenarios, L&I results we typically see tend to be in the $30,000 – $60,000 range on the lower end, and $100,000 – $200,000 on the higher end. ESD results are generally lower, and rarely exceed $100,000. For these businesses, an audit is a blow to finances, and changing course becomes particularly critical since repeat offenders will expose themselves to more devastating fines in their next go-around.

 Scenario 3 – Significant Risk

(Typically many workers, and/or professions with a significant injury risk e.g. logging, roofing, trucking)

Most of the businesses that we’ve seen get devastated by worker misclassification (to the point of having to shut down operations/declare bankruptcy) are businesses that misclassify workers in industries that involve high risk of injury.

These businesses/industries are in fact regularly targeted for audits because they are a drain on our state’s insurance resources, so often it’s just a matter of time before it’s your turn to be audited.

Typical financial consequences:

In the logging industry, a business can owe up to $17 per hour for each misclassified worker, and over the course of three years, that can easily result in an assessment that exceeds $500,000.

In the roofing industry, a business that misclassifies workers can find itself owing $5.96 per hour, per worker, and over the course of an audit period, can find itself with an assessment easily exceeding $200,000. Other high risk construction business can see similar assessment amounts.

In the trucking industry, companies that hire independent contractor drivers will often find themselves running up against several hundred thousands of dollars because of the number of drivers and the number of hours on the road/worked.

Audits by ESD do not present the same degree of risk as an L&I audit. And again audits by the IRS are not as prevalent, but obviously would lead to significant financial exposure if you were lucky enough to be selected.

For these businesses, if they’re able to survive an audit, it’s critical to change course as it is highly unlikely the business would survive a second audit.

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