Employee or Independent Contractor? Misclassification Can Be Costly

Do you have “independent contractors” working for you? Have you thoroughly researched and analyzed their relationship with your company to ensure they are contractors and not employees? Many employers see an economic advantage in hiring independent contractors versus employees.  With independent contractors employers do not have to pay payroll taxes, the minimum wage or overtime, or reimburse them for business expenses incurred in performing their jobs. Additionally, 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. However, if you treat an employee as an independent contractor, it can be a very costly mistake.

Earlier this year California passed Senate Bill 459 adding a new Labor Code 226.8, which imposes penalties of from $5,000 – $25,000 for “willful misclassification” of an employee as an independent contractor. These fines are in addition to any employment taxes and insurance found owing.

There are a number of resources that provide guidance in determining the appropriate classification.

California’s Employee Development Department’s (EDD)  Employment Determination Guide provides a Worksheet on Employment Status that includes a battery of questions that will help you determine classification.  The IRS uses 20 factors to evaluate the validity of independent contractor classifications:

1. Level of instruction
2. Amount of training
3. Degree of business integration
4. Extent of personal services
5. Control of assistants
6. Continuity of relationship
7. Flexibility of schedule
8. Demands for full-time work
9. Need for on-site services
10. Sequence of work
11. requirements for reports
12. Method of payment
13. Payment of business or travel expenses
14. Provision of tools and materials
15. Investment in facilities
16. Realization of profile or loss
17. Work for multiple companies
18. Availability to public
19. Control over discharge
20. Right of termination

More information about each of these factors is in the IRS publication. As always, consult with your tax advisor or an employment attorney for specific questions about classifications.