What is Worker Misclassification?

Worker misclassification describes incorrectly identifying individuals as independent contractors when they are really employees.

Effective January 1, 2021, changes adopted by Virginia’s General Assembly explicitly conform to the IRS definition of worker misclassification. This definition assumes that an individual performing services for an employer for remuneration -- payment for their work or services -- is an employee unless the business can show that the individual is an independent contractor according to IRS guidelines. Virginia Tax will use applicable IRS guidelines to make worker classification determinations.

Virginia’s Office of the Attorney General has launched a Worker Protection Unit, a multidisciplinary team of prosecutors and attorneys who will focus on educating Virginia workers on their rights, and investigating, stopping, and prosecuting exploitation of Virginia workers, including wage theft and worker misclassification. Virginia Tax will engage with the Worker Protection Unit as requested and allowed by law.

Why is Worker Misclassification Important?

Virginia Tax is conducting regular audits looking into worker misclassification. Businesses that misclassify their workers can be found liable for civil penalties.

How to Classify Your Workforce

As a general rule, anyone who performs services for you is your employee if you have the right to control both what will be done and how it will be done.

The IRS Guidelines for classifying workers fall into 3 categories (behavioral control, financial control, and type of relationship) with assessment questions for each.

  • Behavioral control: Does the employer control or have the right to control what the worker does and how the worker does their job?
  • Financial control: Are the business aspects of the worker’s job controlled by the payer? This includes aspects such as how the worker is paid, who provides tools and supplies, etc.
  • Type of relationship: Are there written contracts or employee-type benefits such as pension plans, insurance, vacation pay, etc.? Will the relationship continue and is the work performed a key aspect of the business?

What to Do If You’re Selected for a Worker Misclassification Audit

We’ll be starting with businesses and industries that have issued 1099-NECs and 1099-MISCs to determine if these individuals were appropriately classified as independent contractors. 

If selected, you should review the list of required documents (e.g. W-2s, 1099s, cash disbursements journal, check registers, petty cash, etc.) your auditor provides at the initiation of the audit. You should also confirm with your auditor the period of time under audit - so you’ll know for what period of time documentation is required.

If You’re Found to Be In Violation

If an audit finds an employer in violation, they will be subject to an escalating set of penalties:

  • First audit: up to $1,000 per misclassified individual
  • Second audit: up to $2,500 per misclassified individual
  • Third or subsequent audits: up to $5,000 per misclassified individual

In addition to the penalties, if misclassifications are found during a second audit, then that employer will be barred from certain government contracts for up to a year, and up to 2 years for subsequent offenses. Businesses found to be in violation are also liable for withholding taxes for any individual who was improperly classified for the period they were employed, as well as penalties and interest on those taxes.

For specific information about your rights following an audit, please see pages 7-8 of the agency’s Taxpayer Bill of Rights.

Additional Resources