Employers often misclassify employees as independent contractors so that they can avoid paying payroll taxes, minimum wage or overtime, and complying with other employment laws, such as providing meal and rest breaks and workers’ compensation coverage. Misclassifying an employee as an independent contractor without a reasonable basis can lead to steep penalties and other significant legal consequences. Thus, it is critical that employers properly classify their workers.
What’s the Difference?
The distinction between an independent contractor and an employee is not always clear. Numerous factors are considered in determining the status of a worker. Generally, if the employer has the right to control how the work will be done, and not just the result of the work, the worker is an employee. The following are some general guidelines.
An independent contractor typically:
- is engaged in a distinct occupation or business
- operates under a business name
- is a specialist who works without supervision
- has his or her own employees
- provides his or her own tools and place of work
- sets his or her own hours
- advertises his or her business services
- invoices for work done
- has more than one client
Typical examples of independent contractors include lawyers, doctors, dentists, engineers, architects, accountants, chiropractors, contractors, and subcontractors.
An employee typically:
- performs duties dictated or controlled by others
- receives training for work to be done
- uses company-provided equipment, tools, and materials
- works hours or days dictated by a company
- gets paid on an hourly, weekly, or monthly basis
- works for only one employer
There is no set definition of an “independent contractor” for all purposes, and not one single factor is determinative. The determination must be made on a case by case basis. Additionally, depending on the state or federal agency involved, the factors that get considered vary.
The existence of a written agreement purporting to establish an independent contractor relationship is not determinative. Nor is the fact that a worker is issued a 1099 form rather than a W-2 form.
Why is it Important?
If you misclassify your workers as independent contractors, you could be liable for many years of back taxes and penalties for unpaid federal and state income taxes, Social Security and Medicare taxes, and workers’ compensation and unemployment insurance premiums. You may also be liable to the worker for overtime pay, meal and rest period violations, reimbursement of business expenses, plus interest and penalties. The costs of misclassification can be extremely high and potentially devastating for some businesses, especially those highly reliant on independent contractors.
The U.S. Department of Labor as well as state task forces have been cracking down on businesses misclassifying their employees as independent contractors. The IRS has also been actively seeking what is estimated to be billions of dollars in lost tax revenues due to misclassification of independent contractors.
Under California labor law, there is a presumption that workers are employees, and the burden is on the employer to demonstrate that the workers are employees. Thus, employers should thoroughly research and analyze a working relationship before it is established. Employers should also diagnose whether current independent contractors are properly classified. If you are uncertain about whether a worker is an employee or an independent contractor, we advise that you contact an attorney or the appropriate government agency for guidance.