labor lawAdivision of labor law center

Hiring Independent Contractors is a legitimate business model in all states, and true Independent Contractors should receive 1099s for compensation for their services. However, many employers give 1099 forms to people who are misclassified as Independent Contractors when they should have been paid as employees.

Sometimes the employer’s motive is honest - they believe that the worker is truly an Independent Contractor; but more commonly, they pay with a 1099 to keep the overhead cost down and not give the employee the true protection they need for their work.

The basic definition of the “Employee” and the “Independent Contractor” as given by the Employment Development Department (EDD) of California is as follows:

• Employee: An individual who performs services for you and is subject to your control regarding what will be done and how it will be done.
• Independent Contractor: An individual who performs services for you, but you control only the result of the work.

The employer must understand these definitions in order to remain in compliance and not be issued all the fines and penalties.

The IRS, Department of Labor, and many state agencies are taking aim at businesses using Independent Contractors due to the suffering tax revenues everywhere. Paying Independent Contractors with a 1099 eliminates wage withholding, employment taxes, unemployment taxes, worker’s compensation, and offers no pensions and fringe benefits to the worker. The employer may be benefitting now, but the ramifications can be outstanding.

If found guilty of misclassifying workers, the employer will be faced with costly audits by the IRS, EDD, and Department of Industrial Relations, additional taxes, penalties, and interest, plus revocation of state/local license.

The state of California passed a Labor Law in October 2011 designed to crack down on the misclassification of workers as Independent Contractors and dramatically increased the penalties on employers who have been found to have willfully done so. The SB 459 added the following fines:

• California’s Labor and Workforce Development Agency can fine you for “willfully misclassifying” an employee from $5,000 to $15,000 per violation.
• The penalty goes up to $25,000 per violation if you commit a “pattern and practice” of “willfully misclassifying” workers.
• There’s joint and several liability for consultants (but excluding practicing lawyers) who advise employers on such independent contractor engagements.
• It’s unlawful to charge misclassified independent contractors any fee or take deductions from the compensation paid to them.  Companies cannot deduct fees for goods, materials, space rental, services, government licenses, repairs, etc. provided to contractors who are reclassified.

Paying a true employee with a 1099 and misclassifying them as Independent Contractor may lower the overhead costs now, but should the relationship be terminated, or competitors start to ask questions – both may contact the EDD or the IRS, and the truth will be revealed. The employer will be left having to pay an enormous amount of taxes, fines, and penalties.

The cost is not worth the risk. Be informed of the regulations and the law. Be in compliance at all times for your business.

Resources:

Forms:

DE 231, Information Sheet - Employment

DE 231EEE, Information Sheet - Exempt Employment

DE 38, Employment Determination Guide

DE 1870, Determination of Employment Work Status

Additional Resources:

Employment Status Course

www.edd.ca.gov/Payroll_Taxes/Web_Based_Seminars.htm

Employee or Independent Contractor Tax Seminar

www.edd.ca.gov/Payroll_Tax_Serminars/

Talking about unemployment insurance may be a little bit of getting back to basics for some California employers, who have been in the employer game for some time and are old hat at paying and figuring out the whole unemployment insurance system. But here’s to those employers who are just getting into the game, or those who need a little refresher course—or in this case, a refresher blog.

Unemployment insurance is the system that pays laid off workers a weekly unemployment check to help them tide by until they find their next job. It is meant for workers who lost their job through no fault of their own, so people who quit or who were fired for some sort of disciplinarian issue do not qualify for it according to the letter of the law in California (and in most other states as well).

All of this system, as old hat employers know, is financed straight from the state employers themselves, through tax contributions. These payments come in the form of taxes that are figured out on as much as the first $7000 of wages paid to each worker under your hire. The actual percentage that you pay on that $7000 per employee, though, depends on each employer.

It is determined by the state of California based on how much they have had to pay to your former employees in the past. So in other words, the more that the state has paid in unemployment benefits to former employees of yours in the past, the more you will pay in unemployment taxes going forward.

The key then in part to reducing your unemployment taxes is to reduce the number of workers that are out there claiming unemployment insurance. You can also help out the process by providing accurate information on all of your laid off workers, through information you get on your exit interview forms and employee resignation documents.