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Independent Contractor or Employee? How CSI Fixes Misclassified Workers

June 5th, 2023 | 8 min. read

By Bret Asmussen

Determining whether a new worker should be an independent contractor (1099) or an employee (W-2) is one thing, but what do you do if you think you misclassified a worker in the past - and what are the consequences?

First, determine what their classification should actually be. It’s not uncommon that small business owners find their 1099 workers should really be W-2 employees. If one or more workers need to be reclassified - or if you are not confident in classifying them - contact your payroll provider to help you make the change.

At CSI Accounting & Payroll, we’ve worked with small businesses for over 50 years. We’ve found that many small business owners struggle with this topic, with as many as 30 percent of small businesses misclassifying at least one worker. They often want to know:

  • What is the difference between 1099 and W-2 workers?
  • What are the signs that I’ve misclassified a worker?
  • What are the consequences of misclassifying a worker?
  • How does a payroll provider fix misclassified workers?

Blog - Independent Contractor or Employee How CSI Fixes Misclassified Workers

Independent Contractor vs. Employee

When it comes to classifying workers, businesses have two primary options: 1099 contractors and W-2 employees. Determining which is best for your business depends on a variety of factors, including: 

  • The nature of the work
  • The length of the project
  • Your budget

Independent Contractors

1099 contractors are self-employed individuals who work for your business on a contract basis. As such, they are responsible for paying their own taxes, and you are not required to provide them with benefits or withhold taxes from their paychecks. 

This arrangement offers businesses flexibility and cost savings, making 1099 contractors a great option for short-term or project-based work.


On the other hand, W-2 employees work for your business on a regular basis. As their employer, you are required to withhold taxes from their paychecks and may be required to provide them with benefits such as health insurance and paid time off. 

While this arrangement may be more expensive, W-2 employees offer stability and loyalty to a business. 

Making the Distinction

To make things simpler, the distinction largely depends on how much control and responsibility you have. 

If your worker has more flexibility in how they work and how they are paid, plus they must take more responsibility, then they are probably an independent contractor. If you make most decisions surrounding activity and pay, plus you take responsibility for potential errors, then they are probably your employee.

If you’re feeling hesitant about making the decision yourself, filing Form SS-8 is another option - this allows the IRS to make the determination for you. 

Otherwise, working with a professional accounting and payroll service like CSI Accounting & Payroll can ensure that your workers are correctly classified. 

Signs That a Worker Is Misclassified

While independent contractors may seem like a cost-effective option, they can also pose a risk to businesses. You may get tipped off by an audit or advice from your accountant that a worker is misclassified.

Many 1099 workers do not file their tax returns because of the method they are taxed, which can result in penalties for both the worker and your business. If you have several independent contractors who don’t file, the government may find it easier to perform just one audit - on your business.

You also would not be providing necessary insurance benefits for workers who should be classified as employees. Workers who are misclassified may file a claim for unemployment or workers' compensation benefits, putting you at risk for costly legal fees, penalties, or even an audit. 

It’s also possible that a worker may realize they’re misclassified and report you. Don’t rule that one out, either!

Consequences of Misclassifying a Worker

As briefly mentioned in the section above, misclassifying a worker can have a range of serious consequences for your business. It may also have some indirect consequences on your misclassified worker.

The more mild consequences are back taxes, penalties, and interest on unpaid taxes, but they can add up quickly! 

As for larger consequences, businesses that are found to have intentionally misclassified workers may face criminal penalties, including steep fines and even jail time. Don’t forget about the risk of an audit!

As your business grows, you need to keep a closer eye on worker classification due to the potential for class action lawsuits from your workers. 

While workers don’t face direct consequences for misclassification, they may find it more difficult to obtain benefits or show a consistent income, which can affect their ability to get credit or access other related resources. 

How CSI Fixes Misclassified Workers

CSI Accounting & Payroll can help you set up a new worker or adjust an existing misclassified worker.

New, Unclassified Worker

If you are just hiring a new worker and would like CSI Accounting & Payroll to help you classify them and properly set them up, just let your payroll specialist know! Otherwise, if you are not an existing client of CSI, you can mention this in your onboarding as a priority topic.

Our process for classifying a worker is simple. It consists of looking at the potential relationship between you and your worker and asking a series of qualifying questions. 

If you chose to fill out IRS Form SS-8, you would be held to classifying that worker by the results you receive, but CSI will only advise you in the direction we feel is best, based on our thorough discussion.

If we find and agree that your worker should be classified as an internal W-2 employee, we will:

  • Set them up as an employee in our payroll system
  • Arrange their payroll taxes
  • Establish their workers’ compensation insurance
  • Ensure they’re being properly reported to the government

Existing, Misclassified Worker

If you’ve been in business with a worker for a while but are concerned that they may be misclassified, it’s both a very similar and very different story than if they were a new hire.

We would still analyze and agree upon a classification. If it stays the same, then there is nothing that needs to be changed. However, if they were a 1099 contractor but should have been a W-2 employee, we need to fix this.

Following all of the same steps above, we would register them as an employee. 

Afterward, we will need to fix the past by performing payroll back taxes. Going all the way back to when the worker was first misclassified, we need to reclassify their 1099 wages as W-2 wages so your employee can get their Form W-2 at the end of the year. We will fix taxes and file the returns. You will face a fee for back taxes, plus penalties and interest.

Correctly Classify Workers and Avoid Costly Consequences

It’s crucial for businesses to properly classify their workers as independent contractors or employees to avoid potential legal and financial consequences. Now that you’re aware of the differences between the two types of workers and the signs of misclassification, you can do exactly that. 

At CSI Accounting & Payroll, we can help you properly classify new workers and fix misclassified workers. Working with a payroll service ensures your workers are correctly classified in both the past and moving forward.

If you would like to see if CSI can be a good fit for your business, click the button below for a free consultation:

Not ready to talk? That’s okay! First, learn more about how and when to switch payroll providers.

Bret Asmussen

Bret began working at CSI in 2007. Over the years, he worked his way up from an entry-level marketing position to his current role of manager of our payroll service. Bret is largely responsible for the growth of our payroll division over the last several years. His previous experience and knowledge in sales and management are exemplified in his success here. Bret has a college degree in Computer Networking, a skill that certainly comes in handy in an office environment. Bret is also a Certified Payroll Professional (CPP). Fun Fact: As an active duty member of the United States Marine Corps, he served in Operation Desert Shield and Desert Storm.