Business Law Blog

The Importance Of Properly Classifying Employees

Posted by Amanda Butler Schley | Jan 25, 2022 | 0 Comments

Why is it so important to properly classify workers? The misclassification of employees can result in a large bill for back employment taxes, including interest and penalties. Our team wants to help you avoid dealing with the pitfalls of employee misclassification so we've put together this guide detailing how to properly determine if a worker is an independent contractor or employee.  We also discuss the specific penalties associated with failing to properly classify a worker.

Why Do Businesses Misclassify Employees?

Most companies don't intentionally misclassify employees, they simply make a mistake when determining if a worker should be an employee or independent contractor.

However, to put it plainly, some companies do choose to purposefully misclassify employees to save money. An employer doesn't have to pay the following expenses for independent contractors:

  • Workers' Compensation Insurance;
  • An employer's share of Social Security and Medicare taxes;
  • Unemployment compensation tax;
  • Overtime pay.

It might seem like a good idea at the time but if this intentional misclassification is discovered, the penalties can be steep.

How Do Businesses Get Caught Misclassifying Employees?

The organization that is in charge of enforcing proper employee classification is the Department of Labor's Wage and Hour Division. There are two common ways that this division discovers issues with employee classification:

  1. A worker files a complaint with the Louisiana Department of Labor or the U.S. Department of Labor and an investigation is launched.
  2. An audit is performed.

The DOL issues two types of audits, a targeted audit and a random audit. The targeted audit begins when one or more employees have filed a complaint and a random audit is just that, random.

What Are The Penalties For Employee Misclassification In Louisiana?

The IRS and DOL can both issue penalties for employee misclassification.

IRS Penalties

The IRS can enforce the following penalties:

  • 40% of the FICA taxes that were not withheld from employees;
  • 100% of the FICA taxes an employer should have paid for employees;
  • A 1.5% of each worker's wage penalty;
  • A $50 fine for each W-2 that should have been filed for an employee.

If it can be determined that the employer purposefully misclassified employees, additional fines and penalties may be imposed.

DOL Penalties

When a company misclassifies employees, they violate the Fair Labor Standards Act (FLSA). This violation opens a company up to:

  • Criminal penalties of $1,000 per misclassified worker;
  • Up to a year of prison time if the IRS determines that the misclassification was intentional;
  • Wage claim audits;
  • Worker's compensation penalties;

It may also be possible for employees to file civil lawsuits against their employers.

These penalties and the legal costs that will be incurred can be avoided by properly classifying each worker.

How To Determine If A Worker Is An Employee Or Independent Contractor

The Internal Revenue Service (IRS) has created an outline that helps employers determine if those they are hiring should be classified as an employee or independent contractor. Here are three factors that need to be considered during this process:

Financial Control

When a person has financial control over a business, they have the right to control the business operations. How does this apply to classifying a worker?

Typically, an independent contractor is not reimbursed for their business expenses. They are in a position to benefit directly from any profits made during the course of work and can also be significantly impacted by losses. An independent contractor may also have made an investment into the their own business, such as the purchase of tools. From a payment perspective, most independent contractors are paid a flat fee.

Employees do not stand to be presonally impacted by any profits or losses, are typically reimbursed for business expenses, are paid an hourly wage or salary, and haven't invested in the business or the resources used by the business.

Behavioral Control

Behavioral control refers to the right that an employer has to direct how a person completes a job.

An employer can tell an employee how to perform the work they are completing, which tools to use, and can choose when and where the work is completed. Employees are frequently provided with extensive training.

Independent contractors are typically hired to do a task and allowed to complete their work with their own tools and resources. Essentially, an independent contractor has more control over when and how a job is completed.


What is the relationship between the employer and the worker?

An employee is typically offered benefits such as health insurance, a 401K, and vacation time. The relationship between an employee and employer is also seen as “permanent” until one party decides to sever ties.

Independent contracts frequently have contracts in place that describe the exact relationship between the business and the contractor. This contract will describe the work to be performed, the timeframe in which the work will be completed, and the cost of the provided services. Contracts are typically short-term and open for requent renewal.

In cases where the correct classification isn't clear, it might be beneficial to seek legal assistance.

If you have questions regarding employee classification contact the experienced legal team at Business Law Group. Our goal is to help you avoid legal issues regarding employment and maximize overall business success.

About the Author

Amanda Butler Schley

Ranked as a Top Rated Business and Commercial Attorney, I have more than a decade of experience representing boutique hotels, family-owned businesses, privately owned restaurants, breweries, artists, executives and entrepreneurs.


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Who We Are

Business Law Group is a boutique business services law firm in New Orleans, Louisiana. Our focus is on understanding the legal pitfalls of your business and industry, as well as the secrets to maximizing your legal leverage at every opportunity and in every negotiation. We work selectively with clients that aren't ready for the overhead expense of an in-house general counsel, but understand the advantages of having a trusted legal advisor on their team. Amanda Butler has been ranked as a Louisiana SuperLawyer, New Orleans Top Lawyer, Best Lawyers, and in Leaders of Law.