There is genuine concern about the growing potential risk of misclassified independent contractors and resulting audits by the IRS and California agencies such as the EDD.  The threat and associated extensive financial risk and liabilities are genuine and immediate.  Recent developments based upon a recent California Supreme Court case (Dynamex) have changed the nature of the classification of independent contractors.  How have recent developments changed the methods of classifying independent contractors?  What is the genuine risk to my company?  What factors should I consider and how can I reduce my exposure and liability?

The ”Old Way” of Classifying an Independent Contractor

The “old way” of justifying an independent contractor relationship was based in most part upon issues of control.  Does the company providing the work control the schedule of the worker, the quality of work to be accomplished and provide tools and technology to accomplish the work?  It doesn’t take a Harvard Business School graduate to understand the huge cost savings of misclassified independent contractors versus an employee relationship.  The savings in payroll taxes, benefits, unemployment, workers’ compensation and overtime are easily calculated.  Yet this is the basis for your greatest risk.

The Important New Changes and “ABC” Test

The Supreme Court has retroactively implemented an “ABC” test to determine if an independent contractor is actually a misclassified employee.  In order to provide work to an “independent contractor” the provider of work must prove all of the following:

• “that the worker is free from control and direction over performance of the work both under the contract and in fact.” and
• “that the work provided is outside the usual course of the business for which the work is performed,” and
• “that the worker is customarily engaged in an independently established trade, occupation or business.”

 

There is another extremely important new change as a result of the recent Supreme Court ruling: all workers in California are legally presumed to be employees unless the provider of work can prove otherwise.  This means all employers now have the legal burden of proof to establish that any independent contractor working for their company meets all of the elements of the above ABC test.

What is Really the Potential Risk of Misclassified Independent Contractors in San Diego?

What risks do you face as a result of the recent Supreme Court decision?  One of the most severe potential risk of misclassified independent contractors is having to retroactively pay each independent contractor as if they were originally hired as an employee.  You will next be required to pay all back payroll taxes, unemployment, workers compensation and other federal, state and local payroll taxes for a look-back period of four years.

This is in addition to a civil penalty for misclassification of $5,000 to $25,000 per incident to the State of California.  You are not allowed to make any deductions from these payments, or charge any “fees”.

Opening the Door to a Wage and Hour Lawsuit or PAGA Action

The next step is a lawsuit by the former independent contractor, now employee, seeking unpaid overtime and compensation for benefits they would have been entitled to as an employee such as healthcare and matching retirement contributions.  The agencies and courts will side with the employee, and this issue has generated liabilities that financially hamstring businesses or force the closure of a company outright.

Plaintiff’s attorneys are actively advertising for independent contractors who might be misclassified.  This will lead to an immediate wage and hour lawsuit and potentially a class action under PAGA.

How Will They Find Out I Have an Independent Contractor?

The primary risk is a simple EDD payroll audit.  The first question will relate to any 1099s working for your company, leading immediately to the ABC test.  Further, California employers are now required by law to report independent contractor to the Employment Development Department (EDD) within 20 days of either:

• Making payments totally $600 or more, or
• Entering into a contract for $600 or more with an independent contractor in any calendar year

 

Nex, consider the end of employment for an independent contractor.  All it takes is one unemployment claim by a former independent contractor or a complaint by the worker to any California Labor Agency and you are suddenly facing extensive litigation with potentially business-ending financial exposure.

The Potential Risk of Misclassified Independent Contractors is Genuine

The new rules are generally based upon the economic relationship between the parties.  Does the work of the independent contractor contribute directly to your core business or the profitability of your company?  If so, the State of California says they should be employees, not independent contractors. The difficulty of the work performed and the skill required to do so are also new factors in this equation.

It is time to reconsider how you classify workers in your business.  The genuine concern about the growing potential risk of misclassified independent contractors requires your immediate attention.  This issue can and will cost your business a tremendous amount of money.  We invite you to review the strong recommendations of our clients and contact the Watkins Firm or call 858-535-1511 for a complimentary consultation today.  Learn about the new laws and understand the genuine risks and contingent liabilities you face.