Worker Classification Under the Microscope in NC
Currently, employers across North Carolina are taking a closer look at employee classifications – and with good reason. North Carolina’s Employee Fair Classification Act created a standing Employee Classification Section inside the NC Industrial Commission. That means that misclassifying employees isn’t a theoretical risk. There is a funded enforcement unit with its own hotline in place – and that means that businesses that fail to keep proper classification standards can face substantial risk.
That section isn’t examining findings in isolation, either. It’s sharing them across the NC Department of Labor, the Division of Employment Security, the NC Department of Revenue, and even the US Department of Labor. One bad classification call can trigger action from four agencies at once – not to mention the IRS.
The label on the 1099 doesn’t matter. Both the state and the IRS look at the actual working relationship. If your classifications aren’t in order, it can trigger investigations, fines, and penalties for your business.
What Counts as Misclassification (and Why It’s an Easy Mistake to Make)
Misclassification occurs when a business treats someone as an independent contractor when the relationship between the worker and the company functions like an employment arrangement. Several types of businesses are more likely to make this mistake than others, including:
- Seasonal restaurant/event staff
- Construction contractors who work exclusively for one general contractor
- Salon or spa “booth renters” who are actually scheduled and supervised
- Marketing/creative freelancers doing recurring, directed work
Unfortunately, misclassification occurs all too easily. Often, you may genuinely think that a worker is performing contract tasks – but the reality is, that worker may be filling the role of an employee without the corresponding benefits. Here’s the good news: it is possible to fix it before it becomes a more serious problem.
The IRS Common-Law Test: 3 Categories to Self-Audit Against
The IRS uses three key elements to evauate whether a worker is an employee or contractor. Note that no single factor is decisive. As the IRS points out, it’s about the whole picture.
Category 1: Behavioral Control
Do you dictate how, when, and where the work gets done? Employers may need to consider whether they:
- Set hours
- Provide training
- Require specific methods or processes
- Evaluate performance the same way you would for an employee
If they do all these things, it could indicate that they are dealing with an employee, not a contractor.
Category 2: Financial Control
Does the worker have their own tools/equipment – and other clients? Can they earn a profit or take a loss based on how they manage the job, or do you simply pay them a flat rate for time worked? Contractors often bring in their own equipment, and they can decide how many jobs they can take on at once. In general, they also determine how many hours they actually spend with each employer. Employees, on the other hand, rely on their company to provide those tools and equipment, and they may not be able to work for anyone else at the same time.
Category 3: Type of Relationship
Is there a written contract describing an independent relationship (usually true for contractors)? Do they get benefits, which is usually something reserved for employees? Is the work ongoing or indefinite and central to your core business – a strong sign of employment – or project-based and peripheral?
A 10-Minute Self-Audit for Every 1099 on Your Books
If you have 1099 contractors on your books, take 10 minutes to run a quick self audit. Ask:
- Could this person work for your competitor next week without any issue?
- If the employee quit tomorrow, would you need to immediately fill their role like an employee’s?
- Do you provide tools and equipment for the worker, or are they expected to provide their own?
- Are you controlling when and where work is completed, or is the worker free to take on those tasks according to the timeline that works best for them?
Document the answer to each question in writing now to help protect yourself later.
What It Actually Costs to Get This Wrong in North Carolina
If you fail to properly classify your employees, it can lead to a number of potential problems.
State Exposure
Common costs include:
- Coordinated recovery of back wages
- Unemployment (DES) taxes
- Workers’ comp premiums
- Penalties
Misclassified workers, according to the EFCA, also have the right to sue directly for double damages plus attorney’s fees.
Federal Exposure
You may have to pay back employment taxes as well as any penalties owed to the IRS. Misclassified workers can also file Form 8919 to claim their share of unpaid Social Security/Medicare taxes directly, which is often what puts a business on the IRS’s radar.
If You Find a Problem, Here’s How to Fix It Before the State Does
If you do spot a problem, there are several options to help you protect your business.
Section 530 Safe Harbor
Businesses with a “reasonable basis” for treating a worker as a contractor – consistent 1099 filing, industry practice, prior audits, etc. – may have relief from federal penalties. It’s usually worth making sure you understand those options before panicking.
Form SS-8
If a specific worker’s status is genuinely unclear, either party can ask the IRS for an official determination.
IRS Voluntary Classification Settlement Program (VCSP)
This program allows eligible employers to reclassify workers as employees going forward with significantly reduced back tax esposure, which can mena a proactive, lower-cost path.
All three of these solutions are options to discuss with a professional, not DIY instructions, since you want to make sure you are choosing the right path forward for your business and your circumstances.
When It’s Time to Bring in Help
A professional classification review – or ongoing HR/payroll support – is a low-cost alternative to a state or IRS audit. If you have questions about your workers’ status or how to be sure you are properly classifying them, bringing in the professionals can help prevent potential missteps and allow you to avoid those penalties. Once contractor status is settled, the NC Employer's Guide to HR + Payroll Compliance can provide a broader compliance picture and help your business avoid potential challenges.
Platinum Group provides cloud HR, payroll, and accounting services to Asheville, Western North Carolina, and businesses across the 48 contiguous United States. As an isolved Network Partner, Platinum Group pairs local, personal service with enterprise-grade HCM technology.
[DISCLAIMER: The information in this article is provided for general informational and educational purposes only and does not constitute legal, tax, or professional advice of any kind. Employment laws and regulations — at the federal, North Carolina, and local level — change frequently, and their application depends on the specific facts of your business. Nothing in this post should be relied upon as a substitute for advice from a licensed attorney or qualified HR professional familiar with your situation. Reading or using this content does not create an attorney-client relationship, an advisory relationship, or any other professional relationship between you and Platinum Group. We make reasonable efforts to keep this information current and accurate but make no representations or warranties, express or implied, about its completeness, accuracy, reliability, or applicability to your circumstances. Platinum Group and its employees, officers, and affiliates disclaim any and all liability for actions taken, or not taken, based on the contents of this article. Before implementing, revising, or relying on any employee handbook or workplace policy, consult a licensed employment attorney.]
