Save Thousands by Avoiding This Payroll Mistake
Employees vs independent contractors is a common issue that can lead to serious financial and legal consequences. Some workers know they are classified as contractors but don’t realize they’re misclassified, meanwhile others have no idea at all.
If you’re an employer or worker dealing with classification concerns, this guide will help you understand:
✅ How to determine if someone is an employee or a contractor
✅ The consequences of worker misclassification
✅ What triggers an audit and who conducts them
✅ How a misclassified worker can correct their status
✅ Whether someone can be both a 1099 contractor and a W-2 employee
Employee vs. Independent Contractor: Key Differences
The IRS uses a 20-point checklist (often cited in legal cases) to determine worker classification. Here are some key factors:
Who sets their hours? Employees typically follow employer-set schedules, while contractors set their own.
Who provides tools and insurance? Employees use company-provided tools, while contractors supply their own.
Can they work for multiple clients? Independent contractors are free to work for multiple businesses.
Is there a written contract? A valid contractor agreement should outline the scope and end date of work.
🚨 Red Flag: Paying a contractor on a regular schedule without invoices—especially based on hours worked—could trigger an audit.
Are the Penalties for Misclassification?
Worker misclassification can result in penalties, interest, and back taxes at both federal and state levels.
Federal Penalties
Civil fines between $5,000 and $25,000 per violation from the IRS
Back payroll taxes, interest, and additional penalties
Potential lawsuits for unpaid employment benefits
State Penalties ( Two Examples)
Illinois: Penalties up to $1,000 per violation (second offenses can reach $2,000), plus $500 per day in workers’ compensation penalties (capped at $10,000).
South Carolina: Fines between $100 and $1,000 per incident, potential six-month imprisonment, and liability for three times the owed wages plus attorney fees.
Who Audits for Employee vs Independent Contractor?
Better question: Who doesn’t?
IRS
State Departments of Revenue
U.S. Department of Labor (DOL)
State Unemployment Offices
💡I have seen each of these agencies audit different employers due to audit triggers. Comparatively, the outcome has never been the same, meaning there is no hard and fast rule book and each employer has different situations that are taken into account with their lawyer.
What Triggers an Audit?
🔹 Worker reports being misclassified via Form SS-8
🔹 Contractor files for unemployment, alerting state agencies.
🔹 An E-Verify compliance audit reveals classification issues (some states, like South Carolina, mandate E-Verify for all new hires).
How Can a Misclassified Worker Fix Their Status?
If you believe you’re misclassified, here’s how to correct it:
📌 File Form SS-8 with the IRS – This requests an official determination of your worker status but could trigger an employer audit. Check out the SS-8 form here.
📌 Report to the Department of Labor – Your state’s labor office can provide a quicker resolution.
Can Someone Be Both a 1099 Contractor and a W-2 Employee?
It depends. (The most accountant answer ever!)
✔️ Allowed: Worker transitions from contractor to employee. They receive a 1099 for contract work and a W-2 for employee wages from their official start date. (This does not happen very often as much independent contractors are happy if their businesses are successful.)
❌ Risky: Classifying someone as both to avoid payroll taxes—this can trigger fraud investigations and serious legal consequences.
Final Thoughts
Employee vs Independent Contractor classification can be complex, but getting it right is essential to avoid fines, audits, and legal trouble.
Regardless, if you have tax questions, I’m happy to help! However, if you need legal advice, I can refer you to a lawyer.
🔗 Need a consultation? Contact me today!
