Independent Contractor or Employee…a Dangerous Game
by Katya Mezek
Determining whether a new hire is an independent contractor or an employee is a critical decision that can have serious consequences if made incorrectly. The reason that companies would rather classify employees as independent contractors is because this means that they do not have to pay payroll taxes, minimum wage or overtime, comply with other wage and hour law requirements such as providing meal periods and rest breaks, or reimburse their workers for business expenses incurred in performing their jobs. Further, employers do not have to cover independent contractors under workers’ compensation insurance, and are not liable for payments under unemployment insurance, disability insurance, or social security. This is what makes classifying a potential hire as an independent contractor so appealing. However, misclassifying a potential hire as an independent contractor can lead to serious penalties, fines, and back taxes.
A relatively new California law, California Labor Code Section 226.8, which went into effect on January 2, 2012, adds another layer of repercussions for the noncompliant employer. California Labor Code Section 226.8 imposes new penalties on employers who willfully misclassify their employees as independent contractors. Willful misclassification is defined as “voluntarily and knowingly misclassifying that individual as an independent contractor.” The law also penalizes employers who charge fees or make deductions from compensation to an individual who has been willfully misclassified as an independent contractor.
Therefore, the determination of whether to classify a new hire as an independent contractor or an employee is not a decision to take lightly and should include a thorough analysis of each potential new hire on a case-by-case basis.
Standards for classification:
Be forewarned, a contract can be drafted with whatever language you want and the title could say Independent Contractor Agreement, bolded, highlighted in bright yellow and underlined but this will not mean anything if, in reality, the person is being treated like an employee. So, in order to determine whether a worker is an employee or an independent contractor the courts will apply a common law multi-factor test and applying it to the reality of the working relationship. While no one factor is determinative, all the factors must be weighed against each other and considered in light of the total circumstances. These factors are:
1) Who has the right to control the worker’s manner and means of performing his or her duties – an independent contractor has more control over the day-to-day details of his or her job than an employee;
2) The skill required in the worker’s job – independent contractors often perform highly skilled jobs;
3) Whether the worker is engaged in a distinct business or occupation – if the worker is engaged in a distinct business or occupation, it is more likely the worker is an independent contractor;
4) Whether the work is done under supervision – the more an employer is directly supervising the worker, the more likely he or she is an employee;
5) Whether the worker can be discharged at will or for cause – allowing discharge at will often weighs in favor of an employer-employee relationship;
6) Who supplies the tools, instrumentalities and place of work – if the worker supplies these, he or she is more likely an independent contractor;
7) The length of time the services are to be performed – discrete jobs are generally performed by independent contractors;
8) The method of payment, whether by time or by the job – payment by time generally signals an employee relationship;
9) Whether the work is part of the regular business of the principal – if it is, the worker is more likely an employee;
10) Whether the parties subjectively believe they are creating an employer-employee relationship.
See S. G. Borello & Sons, Inc. v. Dep’t of Indus. Relations, 48 Cal.3d 341, 350-51 (1989); 38 Cal. Jur. 3d Independent Contractors §3.
Though not dispositive, the most important factor in the analysis is who has the right to control the worker’s manner and means of performing his or her work. This is referred to as the “right to control test.”
Penalties for Misclassification:
On a federal level, unintentionally failing to withhold federal income tax will mean that the employer will be subject to a penalty of 1.5% of the wages paid, which will then be doubled to 3% if the employer did not file a Form 1099-MISC for the worker with the IRS. The penalty for unintentionally failing to withhold the employee’s share of Social Security and Medicare taxes is 20% of the employee’s share of the tax. The penalty is doubled to 40% if the employer did not file a Form 1099-MISC for the worker with the IRS.
On the California State level, penalties include repayment of back payroll taxes, subject to interest and a 10% penalty on the unpaid taxes. Failure to withhold and pay payroll taxes can also result in a misdemeanor charge, and the employer can be fined up to $1,000 or sentenced to jail for up to one year, or both.
If the misclassification is found to be willful under California Labor Code Section 226.8, fines between $5,000 and $15,000 per violation of the law will be imposed but these fines will increase to $10,000 to $25,000 per violation if the employer has engaged in a pattern of violating this law. In addition to fines, a violating employer must post notice of its violation in a prominent location on its website for 1 year. If the employer does not have a website, it must post notice of the violation in each location where the violation occurred, in a prominent area accessible to all employees and the public.
For more information you can visit the following websites: