More Penalties for Misclassifying Employees as Independent Contractors?

The U.S. Senate Small Business Committee recently held hearings on the question of small businesses that incorrectly classify employees as independent contractors.

When I heard about the hearings and how they were positioned, I became concerned. I am concerned because the hearings seemed to lump together two different sets of behavior, as follows:

Behavior #1 — Employers who hire employees but call them independent contractors (often illegal immigrants for jobs that involve physical risks such as construction), pay them in cash under the table, and don’t report the payments at all to state or local tax authorities. These employers are trying to hide their actions.

Behavior #2 — Employers who are trying to do the right thing, hire people as an independent contractors, do not try to hide what they are doing, make the appropriate tax filings with 1099 forms, and believe they have some credible basis for treating the person as an independent contractor.

Behavior #1 is clearly wrong.

Behavior #2 may be perfectly legitimate, or it may have various gray areas. And keep in mind, currently the IRS and state agencies already have authority to take action if someone is misclassified.

Hey, look, if someone is misclassified and should be reclassified, so be it.  I’m not here to argue with existing laws.

But I think it’s pretty scary for business owners if behavior #2 gets treated the same as behavior #1, particularly if our legislators start bandying around harsher penalties. (If they’re holding Senate hearings, who knows where it could go?)

Over at the OPEN Forum, I wrote an article expressing my concerns about lumping together the two behaviors.

Of course, I wrote from the perspective of the small business employer. One commenter over there expressed the other side of the coin, from the perspective of an employee/independent contractor.

So — there are two sides to every story.  Please read the article:

When Did Hiring Independent Contractors Become “Illegal”?

Then weigh in — what do YOU think?

  • Do we need more penalties or more enforcement for behavior #2 above? Or do the laws and regulations on the books already cover situations where the employer makes the wrong call?

Anita Campbell Anita Campbell is the Founder, CEO and Publisher of Small Business Trends and has been following trends in small businesses since 2003. She is the owner of BizSugar, a social media site for small businesses.

17 Reactions
  1. Anita,

    LOL – that’s such a tough choice – My good self is inclining toward #2. However, I hate being wronged when I’m doing right. So, well, I started to consider #1 😀 – IMO


  2. Uggh–

    After the nightmare of doing my own taxes meticulously this year after being on a bedrest pregnancy that ended 5 weeks premature on Jan. 31–during which time I HAD to hire friends as independent contractors, you are freaking me out.

    I will be investigating the gray areas…I found this post by Sannwood’s Tweet, fyi…

    Good to see you still bringing us the important news Anita.

  3. Anita Campbell

    Kara, hope all turned out well with the birth. And don’t get freaked out. These are just hearings at this point (although, like I said, who knows where it will go in the future — that’s what I’m worried about).

    But hiring people short term as independent contractors to get through an emergency is not likely to be deemed an employee.

    Take a look at the IRS 11-part test. That will give you a lot to go on:


  4. The borber between contractor and hidden employment will be always very thin and all the countries around the world are fighting to make a right definition. You define a contractor relationship and the businesses will start to play a new game…

  5. Anita: Another interesting angle to this topic is the growing number of people who, for a variety of reasons, want to be contractors and not employees. If the IRS and related agencies make it tougher for businesses to use contractors, there will be fewer opportunities for those looking for contract assignments.

    I’ve be following the IRS employee classification suit against Fed Ex because I think it will have a major impact on employment classification. MSN has a good article on this suit at:

    My blog post on this topic is at:


  6. Less regulations and administration of paper, more jobs available!

  7. With all of these rules and regulations, I’m surprised more people aren’t scared off of starting a business. I definitely think the #1 scenario is wrong. However, I can see how #2 can have both positive and negative aspects to it. I think it’s perfectly fine to classify workers as independant contractors but with a few guidelines in place. I can see how an employer could take advantage for all the wrong reasons. I’m sure it happens more often than we can even imagine.

  8. Wow. I read Senator Kerry’s opening remarks ( ) on the subject of “The Effects of the Underground Economy …” and noticed how he grouped in his phrasing “undocumented workers” which would be clearly illegal with “misclassified employees”, and tied both to avoiding “payroll taxes by hiring workers through shell companies in the Cayman Islands”.

    A bunch of shockspeak if you ask me. As a small business trying to get off the ground, I am amazed at the hoops and hurdles that are required to get rolling. I quite resent small business being related to his “Cayman Islands” profile. I think he doesn’t have a clue.

    A small business documenting and reporting its transactions and with whom to the government is not an “underground economy”. It is a declared economy. If a U.S. citizen chooses to work on those conditions, knowing full well that they are going to be 1099’d, and thus to be responsible to declare and pay their own taxes on their own earnings, then by golly, let the man work. Let him pursue Life, Liberty, and the Pursuit of Happiness.

    God Bless America, the home of the Free!

  9. and BTW, I have attempted to classify all of my workers as employees, in an attempt to keep far from any chance of someone knocking on my door somewhere down the road and closing me down should I ever get this heavy piece of machinery off the ground and in flight. It is no easy thing.

    … What is the weather like on those Cayman Islands?

  10. #1 is clearly wrong but #2 I’m not so sure about. Everythings legit, on the books and income reported – seems fine to me. I think this can get out of hand and wonder what will happen next? Better to just leave things be if you ask me.

  11. Hi Alan, you said it very clearly.



  12. I would definitely agree with Chris. Behavior #2 should not suffer the same punishment as #1. I personally get annoyed at the fact that laws sometimes override common sense. We cannot continue to “fix” holes in our legislature by creating smaller ones.

  13. @ Garry Grant

    Never seen such a bladent attempt at creating controversy to generate traffic.

    @ Anita

    Is your SPAM plug-in working? 🙂

  14. Anita Campbell

    Hi Ben, methinks somebody doesn’t like Garry and is playing a nasty trick on him. I don’t know if any of it is true but I don’t want to be publishing something that could be construed as defamation, so I deleted the comment.

    Ai yi yi, if it’s an employee or contractor who left the message, speak up to your boss, please.

    If it’s a competitor, go somewhere else and do that stuff. 🙁


    PS, Ben, yes, the spam filter is working, but that was not automated spam, but rather someone who left a comment directly.


    Hi Anita,
    I took your advice on sending in an SS-8 form to the IRS. In the mean time, my former employer knows this and has filed an injunction in retaliation to keep me from working because I had a non-compete clause, which a judge upheld. AND I can’t claim unemployment because I was not classified properly. The IRS will not make a determination until this June (maybe) because they are swamped. I have now started working with the state on their investigation.
    Never did I want to be an Independent Contractor. I didn’t even know what that was. My old boss is pretending to not know what she did wrong. Two more of my coworkers got fired & then not paid for asking what was going on with their worker status. One of them had been sexually harassed and has no rights with the EEOC because of the misclassification.
    These small business owners need to be punished. #2 is as bad as #1. They are not as naive as they pretend to be. The workers are the ones being tricked. I did not determine my pay rate. I was paid hourly. Some of these people making comments don’t get it.
    THANK YOU, Anita, for trying to bring this to light, because most people have no idea what I’m talking about.

  16. stop cry’en, what a bunch of sissies. No one is making you take a IC’s job. Bottom line is if you need the money and like getting paid in cash you are going to do what is right for you and your house hold first and foremost, period. Sally the victim, no one tricked you wake up. You needed a job saw the money and ran with it, no one put a gun to your head, I’m sure. So why call foul now, GOD get a life and take responsibility people. Yes by the way I am a slave driver…you maggots…have a nice day.

  17. Dear Bla Bla,
    1. I wasn’t paid in cash, I was 1099’d and paid my taxes quarterly like I was told.
    2. I was 21 at the time and did not know the difference between the 2 classifications and WAS grateful for having a job.
    3. I was fired when I figured out what was going on, so obviously I did not know in the beginning. FYI, I would not have stayed anyway after I figured it out.
    4. Now I can’t work and I’m buried in lawyer bills & court fees because some b!tch didn’t feel like paying her taxes and I have no employment protection rights.
    5. If you are one of these people who does take advantage of others like her, you might want to re-evaluate how you treat your workers because they are in a position to burn you.
    6. I’m not a sissy.