In the litigation frenzy facing California employers, more and more lawsuits are being filed to determine whether someone who has been retained as an “Independent Contractor” meets the test or whether the person should have been classified and treated as an “employee”. Employers (and their legal counsel) must conduct a thorough fact driven analysis determine the appropriate classification. A mistaken classification can lead to substantial liability in a variety of areas which will be addressed below.

Who is an Employee? Any person rendering actual service in any business for an employer, whether gratuitously or for wages or pay, whether the wages or pay are measured by the standard of time, piece rate, task, commission or other basis¹.

Who is an Independent Contractor? “Any person who renders service for a specified recompense for a specified result under the control of his principal as to the result of his work only and not as to the means by which such result is accomplished” ²

Tests: There are different tests used to determine independent contractor vs. employee. Deciding which test to use is a function of whether you are in state or federal court or before a governmental or administrative agency, as each has developed their own version of the test, emphasizing different criteria. The IRS has developed a 20 Factor test from which many other tests have been derived. ³

California Common Law Test: California has a common law test which the courts and some of the administrative agencies utilize. No single factor is decisive but the “right to control the manner and means of employment” is re the MOST important factor⁴ . The number of hours worked or whether the worker has a set schedule is not a controlling factor since employment status may be created after even one hour of work. Other factors include whether:

• The Employer has the right to terminate the relationship at the end of the project or “at will” without cause or notice;
• The Employer pays by the job and not by the time/hours spent;
• The contractor is in a distinct business;
• The parties believe and intend to create an independent contractor relationship⁵;
• The skills the contractor provides are different from the skills of employees of the principal;
• The work being performed is different from work that is part of the regular business of the principal or is it an integral part of the business of the principal;
• The contractor can substitute another’s services or subcontract the work and would the Contractor then pay the sub-contractor directly for their services ;
• The Contractor receives training from the principal;
• The hours of work are regulated by the Principal ;
• The Contractor provides their own tools, supplies, computers, etc.;
• The Contractor has an opportunity for profit or loss depending upon his/her managerial skills in completing the project.

A common misconception is that if the parties agree to treat the relationship as an independent contractor that agreement controls - IT DOES NOT. Other misconceptions include:

• The parties enter into a signed Independent Contractor Agreement
• The worker does not work a consistent schedule but works sporadically
• The worker provides their services to other businesses;
• The worker is paid on a commission
• The worker is not supervised by anyone in the company

Advantages and Disadvantages of an Independent Contractor v Employee Relationship:

Advantages for the principal:

• Relieved of the obligation to withhold employment related taxes, such as contributions toward unemployment insurance, state disability insurance or paid family leave benefits.
• Workers’ compensation insurance need not be provided
• USCIS I-9 Form is not required.
• No wage and hour restrictions such as minimum wage, overtime, meals and breaks.

Advantages for the independent contractor:

• Flexibility of working conditions
• Tax advantages of self employment

Disadvantages for the Principal/Employer:

• Potential tax liability for mis-classification including failure to withhold employment taxes resulting in fines and penalties and payment of taxes not withheld;
• Potential liability for violation of the Wage Order & Labor Code
• Potential penalties for Wage Order & Labor Code Violations

Disadvantages for the Independent Contractor:

• No security of continued work as the contract can be terminated at any time
• Responsible to record time work and pay their own taxes
• Obtain their own insurance

How Misclassification Issues:

• Mis-classifications are discovered when someone is paid as an Independent Contractor and files a claim for unpaid wages with the Division of Labor Standards Enforcement or a civil action, or files a claim for workers’ compensation benefits or unemployment compensation.
• An Audit by the Employment Development Department (EDD), IRS, or other state or federal taxing agency or administrative agency. A state or federal agency examining a independent contractor situation will almost always find that the contractor is in fact an “employee”. As a result, the principal/employer is almost always held liable for back taxes and penalties on behalf of the employee .

Wage and Hour Issues:

Only “employees” are regulated by State and Federal wage and hour laws but these courts and relevant agencies (U.S. Dept of Labor, Labor Commissioner) will make a determination of employee vs. independent contractor status to determine if they have jurisdiction over such claims.

The consequences an employer will face upon a finding of misclassification includes liability for unpaid wages (carrying a 4 yr statute of limitations), unpaid minimum wage, and potential overtime compensation. The failure to pay to an employee what is legally required may result in liability for the back wages in addition to penalties of $100 to $200 per employee per pay period for such violations.

In addition, the employer could face potential liability for violation of related Industrial Welfare Commission Wage Orders or Labor Code sections requiring regulated meal⁶ and rest breaks⁷ , the issuance of proper wage statements ⁸ which results in substantial additional penalties per employee, per pay period or per day. For example, an employer is required to pay an employee one additional hour of wages for each day an employee is not provided a 30 minute duty free meal break when they work 6 hours or more per day⁹ or if the employee is denied one of their 10 minute rest breaks¹⁰ . Additional penalties of $50 to $100 per employee, per pay period can be assessed.

Workers Compensation Issues:

If a worker has not been classified as an “employee” and therefore is not covered by an employer’s workers compensation insurance, the employer can be held liable for civil tort liability by the individual who was injured¹¹ , but also by any third party who may have been injured as a result of the conduct of the “worker”. If the employer fails to secure workers compensation insurance, the employer can be subject to potential liability of up to a $10,000 penalty payable to the State of California¹² , and an additional penalty of 10% of any workers compensation benefits recoverable by the injured worker , and attorneys fees and costs if the injury is litigated.

Conclusion: In light of the significant potential liability facing a company for the misclassification of worker it is imperative to undertake the fact driven analysis and make proper the determination of whether a worker can or should be classified as an employee versus an independent contractor.

1 Labor Code §§350(b), 3351, 3351.5 and 3352.

2 Labor Code §3353

3 www.irs.gov

4 Barton v. Studebaker Corp of America (1920) 46 Cal. App 707

5 Empire Star Mines C. v. California Employment Commission (1946) 28 Cal. 2d 33, 43

6 Labor Code §512, IWC Wage Order Sections 11

7 IWC Wage Orders Section 12

8 Labor Code §226

9 Labor Code §226.7; IWC Wage Order Section 11

10 Labor Code §226.7 ; IWC Wage Orders Section 12

11 Labor Code §3706

12 Labor Code §3710.2