How does Virginia decide whether a worker is an employee or an independent contractor, and what happens to a business that gets it wrong?

Plain-English summary

These are the Virginia Department of Taxation's first guidelines on how to tell whether a worker is an employee or an independent contractor, issued under 2020 legislation (House Bill 1407 and Senate Bill 744) that both set the classification standard and created new penalties for getting it wrong. Like other Department guidelines, this document is not a formal regulation and doesn't carry the force of law, but a taxpayer who follows it in good faith gets the same protection as someone who relied on erroneous written advice if a court later disagrees with a provision.

The starting point is a presumption: anyone paid for services is presumed to be an employee of whoever pays them, unless the worker or the payer proves otherwise. To overcome that presumption, Virginia uses the IRS's own test for classifying workers, which looks at three categories of evidence: behavioral control (who directs how the work is done), financial control (who bears the business's financial risk), and the type of relationship between the parties.

Getting it wrong has real consequences starting January 1, 2021: a misclassifying employer faces a flat $1,000 penalty per misclassified worker found on the Department's first audit, $2,500 per worker on a second audit, and $5,000 per worker on a third or any later audit. Beyond the direct penalty, the Department must notify all public bodies and "covered institutions" (certain public colleges and universities with specific management agreements) of an employer found to have misclassified workers; after a second-audit finding, that employer is barred from public contracts for one year, and after a third or later finding, for three years -- and the bar reaches related firms in which the employer has an interest. Employers also cannot require a worker to sign documentation that misclassifies them, and cannot retaliate against a worker who asserts their classification rights. The guidelines also describe how the Department can share and receive worker-misclassification information with other state agencies (Labor and Industry, the Employment Commission, and others) notwithstanding Virginia's general tax-confidentiality rules, and require the Department to report annually to the Governor and General Assembly on enforcement activity.

Note: these 2021 guidelines were later updated by P.D. 23-88 (7/31/2023), which revised the per-worker penalty amounts (scaling them to employer size) and clarified the debarment procedure, effective for misclassification determinations made on or after July 1, 2023.

What this means for you

Business owners and employers

Don't assume that paying someone as a 1099 contractor, or having them sign an independent-contractor agreement, settles the classification question. Virginia's default is employee status, and the burden falls on you (or the worker) to prove independent-contractor status using the IRS's behavioral-control/financial-control/relationship-type factors. If your business was audited for a misclassification finding occurring on or after January 1, 2021 but before July 1, 2023, these are the guidelines and flat per-worker penalty amounts that applied; for determinations from July 1, 2023 onward, see the size-scaled penalty structure in P.D. 23-88 instead.

Businesses that contract with public bodies or state institutions

A second or third audit finding of worker misclassification can trigger debarment from public contracts -- a real business-continuity risk on top of the direct tax penalty -- and that bar can extend to related firms in which you have an ownership interest.

Accountants, payroll professionals, and HR staff

Because guidelines (rather than binding regulations) represent the Department's interpretation of the law, following them in good faith protects you from penalty and interest even if a court later finds a provision incorrect -- but check whether the determination at issue falls before or after July 1, 2023, since the penalty amounts and debarment procedure were updated by P.D. 23-88.

Common questions

Q: Is a worker automatically an independent contractor if we both agree to it in writing?
A: No. Virginia presumes employee status for anyone paid for services; the worker or the payer must affirmatively demonstrate independent-contractor status under the IRS's behavioral-control/financial-control/relationship-type test, regardless of how the parties label the relationship on paper.

Q: What was the penalty for misclassifying a worker under these original guidelines?
A: A flat $1,000 per misclassified worker on the Department's first audit finding misclassification, $2,500 per worker on a second audit, and $5,000 per worker on a third or later audit, for misclassifications occurring on or after January 1, 2021. (These flat amounts were later replaced by an employer-size-scaled structure for determinations made on or after July 1, 2023 -- see P.D. 23-88.)

Q: Can my business be barred from government contracts over a misclassification finding?
A: Yes. A second-audit finding (after the notice/appeal process runs) triggers a one-year bar from public contracts; a third or later audit finding triggers a three-year bar, and the bar extends to related firms in which the employer has an interest.

Q: Do these guidelines have the force of law?
A: No. They represent the Department's interpretation of the statute but are not formal regulations under the Administrative Process Act; if a court later finds a provision contrary to law, a taxpayer who followed the guidelines in good faith is treated as having relied on erroneous written advice for penalty and interest waiver purposes.

Citations and references

• P.D. 23-88 (7/31/2023) (later Department guidelines that superseded these for misclassification determinations made on or after July 1, 2023, revising the penalty structure and clarifying debarment procedures)

Subject

Guidelines for the Classification of Workers

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-133

Original ruling text

Guidelines for the Classification of Workers

During the 2020 Session, the Virginia General Assembly enacted House Bill 1407 (2020 Acts of Assembly , Chapter 681) and Senate Bill 744 (2020 Acts of Assembly , Chapter 682), which sets forth the Virginia standard for classifying workers performing services for remuneration as employees or independent contractors. In addition, this legislation imposes civil penalties on employers that fail to properly classify an individual as an employee.

These guidelines are published by the Department of Taxation (“the Department”) to provide guidance to taxpayers regarding the classification of workers, as required by the second enactment clause of 2020 House Bill 1407 and 2020 Senate Bill 744. These guidelines are not rules or regulations subject to the provisions of the Administrative Process Act ( Va. Code § 2.2-4000 et seq.) and are being published in accordance with the requirement that the Tax Commissioner publish these guidelines pursuant to the second enactment clause of 2020 House Bill 1407 and 2020 Senate Bill 744, as well as the Tax Commissioner’s general authority to supervise the administration of the tax laws of the Commonwealth pursuant to Va. Code § 58.1-202. As necessary, additional information regarding these procedures will be published and posted on the Department’s website, www.tax.virginia.gov .

These guidelines represent the Department’s interpretation of the relevant laws. They do not constitute formal rulemaking and hence do not have the force and effect of law or regulation. In the event that the final determination of any court holds that any provision of these guidelines is contrary to law, taxpayers who follow these guidelines will be treated as relying on erroneous written advice for purposes of waiving penalty and interest under Va. Code §§ 58.1-105, 58.1-1835, and 58.1-1845.

Classification of Workers

If an individual performs services for an employer for remuneration, such individual is considered an employee of the party that pays such remuneration. To overcome this presumption, the individual worker or his or her employer is required to demonstrate that such individual is an independent contractor.

The applicable standard for making such a determination is Internal Revenue Service (“IRS”) guidance that is designed to help ascertain whether an individual is an employee or an independent contractor. To make a determination pursuant to such guidance, the relationship of the worker and the business must be examined. In any employee-independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered. Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship of the parties. For more information regarding this IRS guidance and how to apply it, see IRS Publication 15-A and IRS Topic No. 762 Independent Contractor vs. Employee.

Civil Penalties for Misclassifying Employees

Any employer, or any officer or agent of the employer, that fails to properly classify an individual as an employee and fails to pay taxes required to be paid with respect to an employee will be subject to monetary penalties. Such penalties are as follows:

$1,000 per misclassified individual for instances of misclassification that the Department finds during its first audit of an employer;

$2,500 per misclassified individual for instances of misclassification that the Department finds during its second audit of an employer; and

$5,000 per misclassified individual for instances of misclassification that the Department finds during its third audit of an employer and on any subsequent audits of such employer.

These monetary penalties apply to instances of worker misclassification that occur on or after January 1, 2021.

Debarment for Misclassifying Employees

If the Department determines during its first audit of an employer that such employer failed to properly classify an individual as an employee and fails to pay taxes required to be paid with respect to an employee, the Department is required to notify all public bodies and covered institutions of the name of the employer. If the Department finds instances of misclassification on subsequent audits, all public bodies and covered institutions are then prohibited from awarding a contract to such employer and to any firm, corporation, or partnership in which the employer has an interest in the following manner:

For a period of 1 year from the date of the notice for offenses found during a second audit;

For a period of 3 years from the date of the notice for offenses found during a third audit or any subsequent audits.

For purposes of applying such debarment provisions, “covered institution” means a public institution of higher education operating:

Subject to a management agreement set forth in Article 4 ( Va. Code § 23.1-1004 et seq.) of Chapter 10 of Title 23.1;

Under a memorandum of understanding pursuant to Va. Code § 23.1-1004; or

Under the pilot program authorized in the Appropriation Act.

These debarment provisions apply to instances of worker misclassification that occur on or after January 1, 2021. Any taxpayer subject to debarment may appeal such action as set forth in Va. Code § 58.1-1821 or Va. Code § 58.1-1825.

Prohibited Actions by Employers

No employer is permitted to require or request that an individual enter into an agreement or sign documentation that results in misclassification of the individual as an independent contractor or otherwise does not accurately reflect the individual’s relationship with the employer. In addition, it is unlawful for an employer or any other party to discriminate in any manner or take adverse action against any person in retaliation for exercising rights with respect to their classification as an employee or independent contractor.

Exchange of Information with Other State Agencies

Unless an exception applies, Virginia’s law provides that the Tax Commissioner, commissioner of the revenue, treasurer, and their staff may not divulge any information acquired in the performance of their duties with respect to the transactions, property, including personal property, income or business of any person, firm or corporation. It is also unlawful for any person to disseminate any confidential tax document which he knows or has reason to know is a confidential tax document. Any person who violates these provisions is guilty of a Class 1 misdemeanor. See Va. Code § 58.1-3.

2020 House Bill 1407 and 2020 Senate Bill 744 include an exception to this general disclosure prohibition that allows the Department to work with certain state agencies to identify employers who fail to properly classify individuals as employees and to enforce the laws regarding the classification of workers. Such agencies include the Department of Labor and Industry, the Virginia Employment Commission, the Department of Small Business and Supplier Diversity, the Department of General Services, the Workers’ Compensation Commission, and the Department of Professional and Occupational Regulation. See Va. Code § 58.1-3.4.

In addition, if any such agency has reason to believe that an employer has failed to properly classify individuals as employees, it is required to notify the Department. Except as otherwise provided by law, such agencies are required to share any information with the Department that may assist in enforcing the provisions of the law regarding the classification of workers.

Reporting Requirement

The Department is required to report annually to the Governor and the General Assembly information regarding compliance with and enforcement of these worker classification requirements. The Department’s report is required to include information regarding the following:

Number of investigated reports of worker misclassification;

Findings of such reports;

Amount of combined tax, interest, and fines collected;

Number of referrals to the Department of Labor and Industry, Virginia Employment Commission, Department of Small Business and Supplier Diversity, Virginia Workers’ Compensation Commission, and Department of Professional and Occupational Regulation; and

Number of notifications of failure to properly classify to all public bodies and institutions.

Additional Information

These guidelines are available online on the Virginia Regulatory Town Hall website, located at https://townhall.virginia.gov , and on the Guidance Documents section of the Department’s website, located at http://tax.virginia.gov/guidance-documents . For additional information, please see the Department’s website at https://tax.virginia.gov/worker-misclassification or contact the Department at [email protected] .

Approved,

Craig M. Burns

Tax Commissioner