Businesses can retroactively claim the Employee Retention Tax Credit (ERTC) through April 2025. This credit rewards businesses for keeping employees on their payroll during the economic crisis brought on by COVID-19.

While this tax credit can be beneficial, you must be careful as an employer when filing for the credit. ERTC misclassification errors, for example, are a common mistake. 

Misclassifying employees as independent contractors can make your ERTC claim inaccurate. This might end in fines, legal issues, and other penalties. 

The Difference Between Employees and Independent Contractors 

Wages you paid to independent contractors do not count toward your ERTC benefits because the ERTC applies to Form 941. This form only accounts for employee wages. 

Independent contractors are typically temporary workers you hire on a project-by-project basis. They set their own hours, provide a set rate for payment, and don’t receive benefits.

Payroll employees, on the other hand, are long-term workers whose work you largely control. They have set hours, salaries, and benefits like health care and vacation pay. 

Warning Signs of Employee Misclassification 

You can determine employee classification between independent contractors and payroll employees based on three factors: 

  • Behavior: Who controls workers’ jobs and how they complete their work?
  • Finances: Does the business control the worker’s finances and tools, or does the worker set a flat rate and use their own tools?
  • Relationship: Does the worker have benefits and a regular wage? Will the worker continue working for the company after their task is complete?

Risks of Misclassification

Risks of ERTC claim misclassification errors include:

  • Government investigation: if you misclassify an employee, you could be non-compliant with labor laws, which may trigger an investigation from the Department of Labor and the Internal Revenue Service.
  • Fines and lawsuits: If the investigation finds you misclassified employees, you might be subject to fines and related penalties.
  • Damage to reputation: If you mismanage employees or break labor laws, even unintentionally, it will damage your reputation.

Correcting Employee Misclassifications

If you find out you accidentally misclassified employees, it isn’t too late to fix it. You can reclassify workers by paying back wages and taxes, potentially including benefits. The IRS also offers a Voluntary Classification Settlement Program that allows you to reclassify workers as employees for future tax periods with partial relief from federal employment taxes. To participate in this program, you must apply through the IRS.

Case Studies of ERTC Claim Misclassification Errors

To help you better understand ERTC claim misclassification errors, the team at Dayes Law Firm offers the following two examples. 

Restaurant Errors 

A restaurant employer misclassified several servers as independent contractors. Because the latter worked regular hours, received a wage, and are under the behavioral and financial control of the business, the employer should classify them as W-2 employees. This means the restaurant owner can reclassify them as employees and claim their wages for the ERTC. 

Construction Errors 

On construction sites, there are often many types of workers. Subcontractors typically work under contractors, who work on tasks specific to their skill set. While some subcontractors may be independent contractors, others are paid regular wages and meet the criteria of a W-2 employee. If you’re an employer in the construction industry, be particularly careful when classifying workers. 

Avoid Misclassification Errors With Dayes Law Firm

Claiming the ERTC can be beneficial, especially for small businesses. However, you must claim the tax credit accurately. At Dayes Law Firm, we’ve helped numerous businesses recover ERTC benefits. We’ll ensure you avoid ERTC claim misclassification errors. Give us a call at (800) 503-2000 or fill out our online form to schedule your free consultation.