Dan
Welcome to Sound Business Insights. I’m Dan Watkins. This episode is about employee misclassification. This podcast is not intended to provide legal advice.
Neil
Dan, there have been some huge changes in classification of employees here in California and some real risks that are resulting for employers. What changed, what got this ball rolling and what do we need to be paying attention to?
Dan
For a long time, the Supreme Court determined there were 14 factors to determine what an independent contractor was. And all of the court of appeals in the state California literally ruled differently on what that meant, <laugh>. So it was incredibly confusing, but we got used to it. Employers got used to it for decades and decades. We all knew you got passed the 14 test and then Supreme Court came up with this case called Dynamex, and Dynamex come up with a saying, all these other things are unpredictable. They’re improper, they’re wrong. I don’t know that I agree with them <laugh>, but it is the way it is because they come up with an A, B, C test, three factors, and those three factors in my mind mean everybody’s an employee.
Neil
Let’s start with that because the law that was changed is that it is now the law of California, that a worker is to be presumed to be an employee and the legal burden of proof lies on the employer. That’s a sea change, isn’t it, Dan?
Dan
Right. Let’s go past my very, very basic assumption. That’s very biased. And talk about the ABC test. The ABC test is, is your worker free from controller direction? Kind of like it used to be. Kind of like it used to be. And did they provide any work outside, use the course of the business. And is the worker usually customarily engaged in an independent establishment trader business? No, nobody is. Nobody drives a truck on their own. Nobody works for a construction company on their own is their own business. They don’t set up their own fictitious business name downtown, this is their job. So then after this AB five came along Yep. And they just turned it into law. And so it is the law and it means that everybody, all 40 million of us change the rules and how we do business in California. And they’ve been doing so and they’ve been fighting these ride share programs. They won a big lawsuit and, but it’s still going back to the legislators still amending laws to make sure that every single person in California can be classified as an employee. And so it costs more in California to hire people.
Neil
Absolutely. So let’s talk about the second prong. Cause I think that’s the first one that’s going to trip up an employer. This (second prong) requires that the work provided is outside the usual course of the business. And in the decision, the court specifically said, for example, if you hire an electrician to come into work on your building, that has nothing to do with the course of your business. But if they’re doing work which directly contributes to your product or your service or your profit, right? You fail item B right out of the box.
Dan
Right. 2 is almost impossible. Yes. If you derive any profit from anything they do, you lose or if they’re doing anything that has to do with your business at all. Right? When it used to not be that way, right. You could hire all these businesses, all these people who were to independent contractor for short term, long term and they were happy. You were happy. I mean, they already had a wife or a husband who had health insurance and all the other things and they just wanted an independent contractor job. But they can’t do that anymore. State of California says no. So that’s got to be freaking out. A lot of employers who are now going, my business model is built on independent contractors.
Neil
Now what? What do you tell them?
Dan
Tell them to buckle up. It’s only going to get worse. <laugh>. Now there are exceptions. Certain professions have exceptions. Shockingly lawyers have exceptions. We’re licensed and the lawyers were the ones that wrote the law.
Neil
Imagine that.
Dan
I know what a shocker. And accountants and probably anyone else that’s a legislature liked, got a pass on having to comply with this law.
Neil
Dan, in an ideal world, what should an employer do?
Dan
Now, when I said buckle up, I meant it because it gets worse. It used to be a penalty maximum was a thousand dollars. Not anymore for government agencies. In addition to all the new rules that make it harder, they put a lot of teeth into the law when I mean teeth, financial teeth into the law and to make it devastating for you not to comply with this law.
Dan
So when you’re doing this and you’re thinking, well, I’m just going to keep doing business as usual, thinking about it as other areas of the law when it, when you first start, okay, it’s okay. And then you get sued or something. Yeah, it’s okay. You pay a penalty a little bit. But if you keep doing it, it gets worse and worse to the, I mean if you get a government agency involved, they can’t just give you small penalties anymore. They give you big ones, $25,000 per violation up upfront. That’s just for openers. And they can push it all the way to criminal violations. Yes. They’ve got all the weapons they can imagine. They just don’t have enough time to get everybody. And they’re out there people. And so we identify, we’re going to talk about some of the penalties, but the reason we’re talking about it is because it’s real.
Dan
Not to get you to call us, but because it’s real. Real dollars. Real money and real people example contractors, right? Mm-hmm. <affirmative>, they like to hire independent contractors. The state of California doesn’t like that. So you’re a contractor, you got some many independent contractors, you’re not paying your workers’ comp on them, it’s cheaper. Right?
Neil
Right.
Dan
Everything’s is great. I don’t have the overhead. And then you’re almost done with your job. The owner owes you about a hundred thousand dollars. It’s a $500,000 job. They’re getting ready to pay and they check with their lawyer, the lawyer checks to see if you have proper worker’s comp. And they say, Nope. They got some, many, many contractors here. And the lawyer says, don’t pay them the hundred thousand. New laws say you don’t have to pay them. And on top of that, even though the job’s completely done, you’ll love this: Tell them you want the other 400,000 back.
Neil
Wow.
Dan
Yes. <laugh>. Does that seem completely, we talked before you get a, you’re driving fast, you’re doing 85 on the freeway, you shouldn’t have the death penalty for your building.
Neil
That’s right.
Dan
Or your business. But this is for your company, this death penalty for your business. It’s, it’s a big hammer. So when you do this, if you’re going to do this, you should probably go see a lawyer to really know what the penalties are and what the rules are, which things you can do, which things you can’t.
Neil
Well, that leads me to two questions. The first one is, I’m sure a lot of our listeners that are employers are thinking, wow, are they going to find me? I’m small potatoes. So how does the labor commissioner or the E D D become aware of these misclassified employees?
Dan
First place disgruntled employees? They always complain to everybody. <laugh> and who’s advertising for them?
Neil
The plaintiff’s lawyers.
Dan
Yes. Who are looking for a PAGA action class. Action …
Neil
Buckle up sweetheart. We’re going for a ride.
Dan
And they also go online and they find the thing with the biggest numbers because they figure that’s going to scare you. It doesn’t always do them well. Doesn’t always make everything great for them. But it sure hurts the employer. Crushes them. So I mean there’s in the construction industry, if you don’t have a lawyer and you are not reforming your company every five or 10 years, if you can, then you clearly don’t have a lawyer <laugh>.
Because there’s not just this law. There are other laws that come into play that give it, make it a big advantage for you to have a new company every so often because these people are out there and contracts are out that you work on. There’s just a hundred reasons why. It used to be deciding how long you should keep the same corporation. It shouldn’t always be forever. Shut the door on the liability and pick up with a new open fresh slate. Basically check your insurance rates. Tail coverage, all those things. A good lawyer with a good CPA could analyze these things and say, how much of a branding problem would it be if you were to form a different company?
Neil
Dan, what are a couple other ways that an employer might get caught in a misclassification situation?
Dan
Governmental claims someone file a worker’s comp claim. So when they file for unemployment, your insurance gets audited, the numbers don’t add up. And then these agencies share, they share with each other. The only reason that you don’t see it happening right away is they have such a backlog of work that for them to get to, it could take a long time, could take forever. But they do share. They don’t just sit around waiting for the phone to ring. They share information and they have no problem finding people to penalize and charge
Neil
Dan. So let’s go through these penalties together. The first one is the California Civil penalty. What’s that?
Dan
Well, labor and Workforce Development Agency is a governmental agency, state of California. And they’re allowed to enforce Labor code section 2 26 0.80. And they can come after you. For what? For willful misclassification.
Neil
What’s the fine for that, Dan?
Dan
Anywhere. All the way up from five thousand to 15 to $25,000.
Neil
And which one do you think they charge more often?
Dan
Their job is to try to charge the most.
Neil
Absolutely.
Dan
And they’re also going to determine that based on whether you’re a repeat offender. So, and how many people are involved, they’re going to search if there’s a large number, the more the numbers there are the worst. You got your multiple government agencies here in California all trying to hurt you. They’re busy. You get a call from one of them and they want to do an audit. Sometimes they show up with a little badge. That happens. Don’t let them come in. Call your lawyer. Don’t let them see any documents. Call your lawyer. Don’t give him anything. Call your lawyer right away. Let us see it. We have all kinds of rights to say no, even to the badge.
I mean I enjoy saying no when the badge is up, no <laugh>. And then it’s time to resolve that claim with that government agency as amicably and as fast as possible before you spend a bunch of attorney’s fees before they label you a really bad guy. And before this goes any farther and spreads to agency and agency and agency, you’ll want to see if you can put a fire out right away before penalties happen. They like to hit you with daily penalties, occurrence penalties, all those things. You can call us. We can determine which attorney-client privilege, which work product, what’s not discoverable to them and what is, and stop you from confessing to multiple crimes right away. And we can make it harder for them to do their job. They’re used to us and they want to resolve it with us. That’s what they’re there for. Well it’s harder if you are in the agency to have to have every single person, every company you deal with has a lawyer talking to you. Lawyers don’t answer crap, they just ask questions. And it makes your job harder. You have a job at that agency to clear so many files. If all your files were lawyer files, it would take you forever. Meanwhile, your friend has only got like four lawyer files, clearing files and clearing files and going to lunch. Call your lawyer, get it resolved before it spreads. And then you get yourself a business checkup. Prepare for maybe some other agencies calling, maybe not. And be prepared. And then it won’t spread.
Neil
Let’s take worst case scenario. We’ve been fined for this civil penalty. The next thing is you’re going to owe back taxes to the feds and to the state of California. How far back are they allowed to look?
Dan
Well, I’m not a CPA. But for regular things they can go back three years. But for criminal fraud they can go back farther. It depends on when it was discovered. If it was concealed. It depends on how much you talk to the government agency.
Neil
So basically we owe back payroll taxes, which we should have collected, to the IRS, to the state of California. And then the IRS is going to add a penalty of 1.5% and double it to 3% If you didn’t file the 1099, the next knock on the door comes from California seeking payroll taxes such as
Dan
it’s worse than that. There’s a special lien when it comes to payroll because California loves its employees.
Neil
Mm-hmm <affirmative>
Dan
that it’s not your company liability, it’s you personally. Mr. Payroll guy. It’s you individually. The person that’s been the fiduciary for handling their payroll accounts. They go right to the individual. There’s no corporate shield when it comes to the employee’s money. So you’ve got personal liability on the line and, and also you’re like a red flag guy because all of a sudden you’re the worst person in the world and they want to bring everything they can down against you for messing with employment accounts for their withholdings. So you’re personally liable.
Neil
Is the company liable behind you?
Dan
Everybody’s liable.
Neil
And then if that isn’t bad enough, so I’ve got to pay three to four years of back payroll, associated unemployment, workers comp, all those things. The next knock on the door is from the employee’s PAGA lawyer.
Dan
Right.
Neil
Class action. What does that open you up to?
Dan
More penalties, more assessments, more trouble. Again, you get the class action lawyer calling, call us right away. You get special rights if you act right away and you can put out a PAGA claim, in it’s tracks. If you act in the first 30 days to six weeks, you can, in the right circumstance, you can literally put that fire out and destroy that case. It’s gone. But if you wait, then you missed your opportunity and you’re fighting it out in court and with lots of money being spent on lawyers.
Neil
And all it takes is one (employee) Dan because, if a plaintiff’s attorney gets a hold of one, then they can make you put up notice in your business. They can go into previous employees that have left your employee the doors wide open and then the lawsuits come at you.
Dan
Whether or not your other employees want to join the suit, they could inadvertently or somehow be involved and they’d have to affirmatively opt out. And so, but there’s opportunities, they keep saying this to get out if you act quick. If they hear nothing else, the first sign of trouble, we can help. And there’s a lot you can do fast that’ll limit the numbers substantially.
Neil
That’s the message, isn’t it?
Dan
The largest lawsuit settlement ever achieved in San County was about a billion dollars.
Neil
Wow.
Dan
And it was an employee misclassification and wage an hour. And it was from a huge defense contractor. And as sophisticated as they are, they still got hit. So if you have your company with 20, 30, 40, 50, even especially over 50 employees get a checkup. It doesn’t take much. Get a second opinion. This is the biggest liability a business can have.
Neil
Yes. Let’s take the opposite approach and say, okay, they haven’t found me yet. I might be one somebody that has several or a few independent contractors. What’s the process to move from a company with independent contractors to employees? And is there a risk that you need to manage when you make that transition?
Dan
You’re assuming you have to move to an all employee company because that’s what the state of California wants you to assume. But I’m your lawyer. I don’t always agree with that. <laugh>. I believe there’s ways you can still have independent contractors and we do it, it’s possible. It can be too expensive or cumbersome to do versus the cost of actually having employees. It can be a factor when you run it all on a profit loss situation and balance it. But yes, you can get around some of these laws by forming different companies entering into, into certain agreements. It’s not just cut and dry. But if you do change over, then I know where you’re going. You’re talking about, well how are the independent contractors going to receive this? Right?
Neil
Right. Do they need to sign away future rights to come back after you? That’s hard to do.
Dan
Yes it is. That’s hard in some circumstances, many situations you can’t or you might not want to bring it up.
Neil
Right.
Dan
<laugh>, why open the door.
Neil
Correct.
Dan
So yeah, that conversion to we’re going to go independent contractor, employee, that’s something you should be supervised by your lawyer. Another thing about this whole penalty phase, if you do these things on your own, and you’re paying into bid contractors and you’re paying this and you have a setup, you’re going to get penalized. But if you’re doing these and you’ve been advised by an attorney or a CPA to do these things and technically it’s determined that it’s in violation, then you won’t get hit with the penalty because it was you relying on professional advice. So your ill will is not there. I mean, you,
Neil
you’re not the bad guy.
Dan
Well you could get penalized
Neil
or a bad girl.
Dan
Yeah. Right. But a CPA or lawyer could be in there arguing, no, you’re wrong. We have a right to do this. And those things get resolved. Unless you’re that big defense contractor that paid a billion dollars <laugh>, they didn’t get resolved the right way. Because California says, well there’s money in there. Pay up.
Neil
Let’s take the example of, I think a common, many employers are just going to say, I’m just going to keep doing what I’m doing and they’re not going to find me. How real of a risk do you perceive this to be?
Dan
Well, obviously the number of employees, the kind of work you’re doing and the licenses involved, all those things going to may factor. So if it’s real, it’s going to happen. Because there’s plaintiff’s lawyers out there advertising a thousand times more than I do. <laugh>. I have a podcast and we have a website, <laugh>, that’s it. They’re on tv, right? They’re on Facebook. They’re on every social media site. They’re getting told if you leave your job or if you don’t want to leave your job, whatever, we’ll make you rich. That’s it. It’s lottery ticket advertising going on to your employees. So yeah, it’s, it’s more likely here in this state than any other state.
Neil
Yes.
Dan
You can learn more about the Watkins firm@watkinsfirm.com or call our office at (858) 535-1511.