Independent Contractor vs. Employee Law: Differences in California.

In California, several important legal rights are limited to employees. To save money, many employers attempt to classify (or often misclassify) their workers as independent contractors instead of as employees. But, what is the difference between an employee and an independent contractor? How can workers tell if they have been misclassified? The answers to these questions could result in workers having greater access to important legal rights in California.

The legal rights at stake.

Workers often benefit from being classified as "employees" rather than as "independent contractors." Employees have numerous rights that independent contractors do not have, including:

  • The right to unionize or collective bargain. ((29 U.S.C. § 157.))
  • The right to be free from many types of discrimination. ((Government Code, § 12940.))
  • Numerous rights under wage and hour laws. (((29 U.S.C. §§ 151–169, 201–221.))
  • And fewer benefits normally offered to employees, like health care or sick time.

The issue of classifying workers is therefore really important. Workers and their families have a strong interest in being properly classified.

The employer's incentives for misclassifying employees as independent contractors.

From the employer's perspective, there are a number of benefits to classifying a worker as an independent contractor. These include: tax savings, exemptions from labor laws, decreased liability, and avoidance of employee benefits.

Tax savings.

Businesses can save several tax-related expenses by hiring independent contractors. For example, employers do not have to pay state or federal unemployment insurance taxes for independent contractors. ((Unemployment Ins. Code, § 656; 29 U.S.C. § 3306.)) Businesses also avoid paying social security taxes by hiring independent contracts. ((29 U.S.C. § 3111.))

Exemptions from labor laws.

The National Labor Relations Act (NLRA) gives employees the right to unionize and collectively bargain. ((29 U.S.C. § 157.)) Independent contractors, however, are not protected by the NLRA. ((29 U.S.C. § 152, subd. (3).)) The federal Fair Labor Standards Act (FLSA) also does not protect independent contractors. When applied to employees, the FLSA imposes restrictions on child labor, minimum wages, and overtime pay. Like federal laws, many provisions of the California Labor Code only protect employees—not independent contractors. In this way, businesses might benefit by working with independent contractors instead of hiring employees.

Decreased liability.

In general, only employees receive protections for wrongful termination or discrimination laws. For example, Government Code Section 12940 prohibits acts of discrimination on the basis of race, religion, gender, sexual orientation, or age, but this prohibition applies only to the employer/employee relationship. Independent contractors generally cannot bring statutory discrimination-based actions. ((Sistare-Meyer v. Young Men's Christian Ass'n (1997) 58 Cal.App.4th 10, 17; see also Mitchell v. Frank R. Howard Memorial Hospital (9th Cir. 1988) 853 F.2d 762, 766.)) So employers could, to some extent, decrease their liability for wrongful termination and discrimination-based claims.

No benefits.

Employers that hire independent contractors often avoid benefits that are normally issued to employees. For example, under almost any company policy, independent contractors would not be entitled to sick pay, medical insurance, life insurance, vacation pay, retirement contributions, or many of the other benefits that businesses often offer employees.

Drawbacks of choosing independent contractors over employees.

Increased liability.

Although employers can often avoid liability simply by hiring independent contractors, rather than employees, they also increase their risks of liability in some areas. For example, an employer who misclassifies an employee as an independent contractor can face substantial damages. These penalties can range from additional taxes to criminal liability. ((See, e.g., 26 U.S.C. § 7203.)) For further information on the risks of misclassification, see our discussion below.

Loss of control and loyalty.

Perhaps the biggest disadvantage from the employer's view is a practical one: the loss of control over the way the worker performs their job. Because control is one of the primary factors in determining whether a worker is an employee or an independent contractor, employers that choose to classify their workers as independent contractors often lose the right to dictate that manner in which the work is performed.

Also, the lack of benefits and rights given to the worker decrease the likelihood that the worker will feel loyal or committed to the work they are performing. As such, businesses may be at a practical disadvantage by choosing to use independent contractors over employees.

Binding contracts.

In many cases, businesses hire independent contractors through contracts for a specific duration. Business may therefore be bound by a contract to continue working with the independent contractor. Employees, on the other hand, are normally terminable at-will. So businesses may be risking contract liability and become wrapped up in binding contracts by hiring independent contractors.

The legal tests.

Clearly, the legal rights at stake are important. But what is the operative test to determine whether someone is an employee or an independent contractor? In most cases, the determinative factor is the degree of control that the employer exercises over the worker. The greater the control, the more likely it is that the worker is an employee, not an independent contractor.

There are, however, several different tests to determine if a worker is an employee or an independent contractor. The appropriate test to use will depend on the facts of the specific case and the context in which the classification is being analyzed. For instance, the IRS applies a test that is worded slightly different from California's Employment Development Department.

In general, however, the most important factor that courts look at is how much control the employer has over the worker. The more control the employer exercises, the more likely it is that the worker is an employee:

o determine whether one performs services for another as an employee, the most important factor is the right of the principal to control the manner and means of accomplishing a desired result. If the principal has the right to control the manner and means of accomplishing the desired result, whether or not that right is exercised, an employer-employee relationship exists.

In addition to control, numerous other factors are often applied. One of the most significant tests looks at the following:

  • Whether or not the one performing services is engaged in a distinct occupation or business.
  • The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision.
  • The skill required in the particular occupation.
  • Whether the principal or the workman supplies the instrumentalities, tools, and the place of work for the person doing the work.
  • The length of time for which the services are to be performed.
  • The method of payment, whether by the time or by the job.
  • Whether or not the work is a part of the regular business of the principal.
  • And whether or not the parties believe they are creating the relationship of employer-employee. ((Tieberg v. Unemployment Ins. Appeals Board (1970) 2 Cal.3d 943, 949; Restatement (Second) of Agency § 220 (1958).))

Misclassification of employees as independent contractors: Penalties for crossing the fine line.

As described above, employers have numerous incentives for classifying workers as independent contractors instead of as employees. Employers, however, face stiff penalties for willfully misclassifying their employees as independent contractors. California Labor Code Section 226.8 makes it unlawful to willfully misclassify an employee as an indpendent contractor. Employers that break this law can be liable for a civil penalty up to $25,000 for each violation. ((Labor Code, § 226.8, subd. (c).)) Penalties imposed under this provision do not preclude other penalties for which the employer may be liable.

To add insult to injury, employers that have been found liable for willful misclassification must display prominently on their website that they have "committed a serious violation of the law by engaging in the willful misclassification of employees." ((Id. at § 226.8, subd. (e).)) So, not only does the employer risk substantial civil fines, the employer could lose business from potential customers.

In addition to the penalties imposed by the California Labor Code, employers may face sanctions by the Internal Revenue Service (IRS) and the California Employment Development Department (EDD). In the most extreme cases, the consequences of misclassification include criminal penalties of up to one year in jail or state prison. ((Unemployment Ins. Code, §§ 2117, 2118.5.)) IRS fines can also reach up to $250,000. ((26 U.S.C. § 6721.))

Finally, both state and federal law provide for penalties related to unpaid minimum wages that may have resulted from the employer's misclassification. ((See, e.g., Labor Code, §§ 204, 210, 1197.1, 1194.2; 29 U.S.C. §§ 216, subd. (b), 260.))

Clearly, the penalties are stiff for employers that want to save a few bucks by classifying employees as independent contractors. In many cases, if it's a close call whether the worker is an employee or an independent contractor, it may be safest to simply classify them as an employee to avoid the risk of government penalties.

Final thoughts.

Employers that wish to exercise a high degree of control over their workers face a significant risk in classifying their workers as independent contractors. Although there are substantial benefits in tax and compensation savings for employers, the risks may not be worth it. Also, worker loyalty is often critical to a business's success. Employers often lose loyalty by misclassifying their workers.

If you believe you may have been misclassified as an independent contractor, you may be entitled to damages from that business. Give us, Optimum Employment Lawyers, a call. We represent clients all over Los Angeles and Orange County. Our consultations are free and we can help you determine your options: (949) 954-8181.