Unemployment Insurance Claim and Department of Labor Audit
Employers must classify workers as employees or as independent contractors. When a worker is classified as an independent contractor, the employer withholds no taxes and issues a 1099 at the end of the year. Because the worker is considered self-employed, the worker pays taxes on his or her own.
Employers must withhold taxes from wages paid to employees. New York law also requires employers pay unemployment-insurance taxes, which are used to fund the state’s unemployment insurance system. Misclassifying employees as independent contractors leads to a labor audit. A labor audit is an intensive process that looks for violations beyond misclassification of employees. Each violation comes with substantial penalties.
The difference between employees and independent contractors
The Internal Revenue Service (IRS) defines employees as workers who perform services that the business controls. A worker is considered an employee even if the employee has discretion and freedom of action. What matters is that the employer has the right to control the details of how work is performed.
On the other hand, the IRS defines an independent contractor as a worker who performs work not controlled by the employer. The employer may control the end result of the work but cannot specify the details of how the work is performed or where it is performed. Instead, the independent contractor is free to perform work on his or her own terms without the employer specifying what must be done and how it must be done.
In making this determination, the IRS examines three categories of the employment relationship: behavioral, financial, and type of relationship. Behavioral aspects are ones that determine if an employer controls what work is done and how it is done. For example, a salesperson required to staff the sales floor and wait on customers would be considered an employee based on the behavioral aspects of his or her work. Financial aspects relate to whether the payer controls the business aspects of the work, such as owning the equipment. Employers must also consider whether the type of relationship is contractual or employee-type.
Consequences of misclassification
Employers often get in trouble when a worker who was classified as an independent contractor files an unemployment insurance claim after termination. After the claim is filed, the unemployment insurance office investigates whether the employment relationship was classified correctly. If the department finds that the employee was misclassified, it will reward the employee unemployment insurance benefits.
This determination has adverse consequences for the employer because as a result of the misclassification, the employer failed to withhold taxes and pay unemployment-insurance tax. As a result, the State of New York will assess the employer the unemployment insurance taxes owed, in addition to penalties, interest, and fees.
In most cases, the discovery of an employee misclassification triggers a labor audit. During a labor audit, the state will look at the classifications of all employees to determine if the employer misclassified any other employees. Auditors generally look at the past three years. They will assess back payroll taxes and penalties for each instance of misclassification.
Labor audits go beyond classification. They also search for any employees paid off the books, as well as any wage and hour or minimum wage violations. Auditors will examine wage and timekeeping records. If legally required records are not in order, additional penalties may be assessed.
Intentional misclassification of workers
When employers intentionally misclassify workers, they open themselves to fraud charges. The State of New York considers misclassification to be an attempt to avoid compliance with multiple legal requirements beyond unemployment insurance, including workers’ compensation, social security, tax withholding, temporary disability, and minimum wage. A labor audit may bring charges in all of these areas.
The State of New York employs a joint task force in conducting investigations into worker misclassification. The task force includes the Department of Labor, the Attorney General’s Office, the Department of Taxation and Finance, the Workers’ Compensation Board, and the Workers’ Compensation Fraud Inspector General. The task force’s mission is to stop worker misclassification in order to ensure that workers receive the protections they are entitled to under the law. The New York Department of Labor also maintains a hotline where employee misclassification may be reported to the task force.
How to ensure against a labor audit
Employers must never intentionally misclassify employees. In cases where employers are unsure about legal classification, they should seek legal advice from a New York employment lawyer. Some cases of classification are obvious, while others may seem to fall in a gray area. An employment lawyer can accurately assess the classification and protect your business from a labor audit.
Employment law covers a vast number of regulations. Employers often find themselves facing audits or lawsuits because they were unaware of misunderstood regulations. Hiring an employment law firm to provide advice and counsel on employment issues can save a firm from experiencing a labor audit and the associated financial penalties.