How to Handle Independent Contractor Misclassifications During an Acquisition

In a small business acquisition, employee classification is an important legal issue. Misclassifying employees as independent contractors can lead to significant fines, penalties, and back taxes. Here’s how to handle independent contractor misclassifications during an acquisition to avoid these pitfalls (and how to avoid this issue when selling your company).

Understanding Independent Contractor Classification

An independent contractor is a worker who provides services to a business but is not considered an employee. The IRS has strict guidelines to determine whether a worker qualifies as an independent contractor or should be classified as an employee. These guidelines focus on factors such as control over work, financial arrangement, and the relationship’s nature.

Why Misclassification Matters

Misclassifying workers can lead to:

• Penalties and Fines: Employers may face fines for unpaid payroll taxes and other penalties.

• Back Wages and Benefits: If workers are found to be misclassified, they may be entitled to benefits such as overtime, health insurance, and retirement contributions.

Steps to Handle Misclassifications

1. Review Worker Classification
   During due diligence, the buyer should review all independent contractor agreements and determine if any workers may be misclassified. Consulting a legal expert with experience in labor laws can help identify potential risks.

2. Correct Misclassifications Before the Sale (Way before the sale!)
   If workers are misclassified, the seller should reclassify them as employees before the acquisition. This involves paying any back taxes, wages, or benefits owed.

3. Negotiate Indemnification
   Buyers can include indemnification clauses in the purchase agreement to protect against potential liabilities from worker misclassification.