Tip of the Day: Beware of the Million Dollar Unemployment Claim

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If your former contractor files for unemployment, pay attention!

When a former employee files for unemployment, it hardly matters to the business whether the individual gets unemployment coverage. Unless the individual had voluntarily quit, benefits are usually allowed. No big deal.

When an independent contractor files for unemployment, however, beware. Unemployment insurance coverage is available only to employees, not to independent contractors. For a contractor to obtain coverage, the state must first determine that the contractor was an employee.

This determination can have far-reaching economic consequences to the business, extending well beyond the individual contractor.

First, if your contractor was misclassified and is deemed an employee, you were not paying
into the state unemployment insurance pool for that contractor — or for all contractors who are similarly situated. The state wants your money and may issue back assessments (and penalties and interest) for having failed to pay into the system — not just for that individual but for all other individual contractors who performed the same type of work.

Back assessments can stretch back years and can add up quickly, particularly for businesses that retain a large number of individual contractors.

Second, the impact of a misclassification finding can quickly snowball beyond the land of unemployment insurance.

If a state finds that a worker was misclassified for purposes of unemployment, the worker was also likely misclassified for purposes of workers compensation and state tax withholding. States will share information internally.

This is a money grab.

If you didn’t pay into unemployment, you also didn’t pay into the state workers compensation fund, and you also didn’t withhold income taxes. Back assessments (and penalties and interest) for failure to pay into the workers’ compensation system and failure to withhold income taxes may follow — and not just for that individual contractor who filed for unemployment, but for every similarly situated contractor. The numbers can add up quickly.

States also share findings of misclassification externally, that is, with the federal government.

More than 35 states have signed information sharing agreements with the U.S. Department of Labor that are specific to independent contractor misclassification. If the state determined the worker was misclassified, the U.S. DOL may be next in line to open an audit and find misclassification under federal labor law — the Fair Labor Standards Act, for instance.

Next in line is the IRS. The IRS and DOL have an information sharing agreement that covers independent contractor misclassification. Failure to withhold federal income taxes, FICA, and FUTA may result in further back assessments, penalties, and interest for this individual and all others similarly situated.

Before long, the single unemployment claim can snowball into a massive liability under multiple state and federal laws, for every similarly situated contractor.

Summary:  Unemployment benefits are for employees, not independent contractors. A finding that one contractor was an employee and is eligible for coverage may quickly snowball into a finding that all similarly situated contractors were employees, and not just for purposes of unemployment, but also for workers’ compensation, state and federal taxes, Social Security, and Medicare.

With back assessments, penalties, and interest for all similarly situated contractors and for all of these coverage laws, a single unemployment claim by a former contractor can snowball into a million dollar liability.

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