Misclassifying Workers as Independent Contractors Carries a Steep Price

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IMGCAP(1)]California now has the nation's most punitive laws against worker misclassification.

While misclassification has always been illegal, businesses found to have incorrectly classified employees as independent contractors now face civil penalties ranging from $5,000 to $15,000 per employee, and $10,000 to $25,000 per employee in instances involving “a pattern and practice” of misclassification.

On top of that, businesses found to have misclassified workers may be required to post notices on their Web sites detailing the misclassification and directing misclassified workers to California's Labor Workforce Development Agency. These penalties are in addition to a long list of other penalties, fines and back wages that may be owed for failure to pay wages correctly.

The motivation for such drastic measures? Money. And more specifically, tax revenue. Workers classified as independent contractors are not taxed with every paycheck as employees are, nor are employers required to pay payroll taxes on workers classified as independent contractors. The state apparently hopes that its punitive measures will deter businesses from even considering classifying individuals as independent contractors.

But the state is seeking to deter more than just businesses. The state also quietly included a provision designed to expand the scope of the new law. Third parties who simply advise businesses to classify workers as independent contractors now face joint and several liability for advising businesses to misclassify employees. Squarely in the state's cross-hairs are accountants and outside human resources consultants who provide consulting services to businesses. Attorneys and internal employees making recommendations to their employer are generally excluded from liability.

California’s new laws undermine a new voluntary self-reporting program instituted by the IRS to help businesses who previously misclassified workers. Under that program, employers who have misclassified workers as independent contractors may significantly limit their exposure to the federal government by self-reporting previous misclassifications. Unfortunately, the program provides no immunity from penalties that may be imposed under California law, and participation in the IRS’s program may be used as evidence of liability under California law.

When can a worker be classified as an independent contractor? There is no easy answer, but the analysis generally depends on a review of several factors. The most important is whether the person to whom service is rendered has the right to control the manner and means of accomplishing the result desired.

Other “secondary” factors include (1) whether the worker is engaged in a distinct occupation or an independently established business; (2) whether the worker or the principal supplies the tools or instrumentalities used in the work, other than tools and instrumentalities customarily supplied by employees; (3) the method of payment, whether by time or by the job; (4) whether the work is part of the regular business of the principal; (5) whether the worker has a substantial investment in the business other than personal services; (6) and whether the worker hires employees to assist him or her.

There is no grace period. The new laws became effective on Oct. 8, 2011—the day on which Governor Jerry Brown signed the bill. Misclassification is obviously a risky proposition.

Jim Fessenden is an associate in the San Diego office of the law firm Fisher & Phillips LLP. He can be reached at (858) 597-9619 or jfessenden@laborlawyers.com.

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