There has been a tendency in recent years for companies to treat workers as independent contractors to avoid administrative responsibilities and additional costs that apply to employees (payroll taxes, workers’ compensation insurance, unemployment insurance, overtime pay, and various employee benefits). In response, the Internal Revenue Service and state agencies have stepped up compliance audits to check whether businesses classify their workers correctly. Employers who have misclassified face a range of government fines and penalties, as well as liability to workers who have misclassified.
California has upped the ante with a new law, effective January 1, 2012, that adds Sections 226.8 and 2753 to the Labor Code. Section 226.8 prohibits any person or employer from knowingly misclassifying a person as an independent contractor, or making any compensation costs or deductions (for example, for goods, materials, or rent of space) to that individual if it would be unlawful to make such fees or discount to an employee. Section 226.8 imposes fines of $5,000 to $25,000 for each violation.
The law does not specify how often an “offence” is deemed to have occurred, leaving open the possibility that multiple penalties could be imposed on a single worker. Intentional misclassification was defined as one that was “voluntary and knowing”. It is not clear how this standard will be interpreted by the courts.
Section 226.8 also requires employers who are found to have violated the law to prominently display on their website a year’s notice specific to the breach.
Any breach of law by a licensed contractor will be reported to the Contractor’s State Licensing Board, which will initiate disciplinary action against the contractor.
Under Section 2753, a person who, for money or other valuable consideration, knowingly advises an employer to treat someone as an independent contractor to avoid employee status for that individual must be held jointly and severally liable with the employer if the individual is found not to have done so. become an independent contractor. This provision is expected to impact outside advisors such as accountants and human resources consultants. Employees who advise their employers and attorneys who provide legal advice are exempt from liability under Section 2753.
Compliance with the new law is complicated by the fact that it does not provide a clear test of whether a worker is an employee or an independent contractor. Under pre-existing legislation, a worker is generally considered an employee if the principal has the power to direct and control the manner and means by which the work is carried out. However, a variety of other factors will be considered, with testing differing under California and federal law, requiring an intensive analysis of the facts for each case.
One compliance strategy for businesses wishing to avoid the burden of labor administration and the risk of improper classification is to secure workers through separate service companies, which employ workers provided to the business, as opposed to businesses which directly maintain independent contractors. .
However, companies wishing to use independent contractors should consult legal counsel, given the difficulty of establishing a proper classification and the potential high costs of failing to do so. Obtaining competent professional advice can reduce the possibility of misclassification, and can also provide the employer with a basis for maintaining that a misclassification is not “intentional”. In addition, a carefully prepared agreement with the contractor and other appropriate documentation (for example, the contractor’s business license and proof of insurance held by the contractor), although not of a decisive nature, can help the company to prove the legitimacy of the independent contractor relationship.