Willful misclassification of “Independent Contractor” status instead of “Employee” brings heavy penalties
The popular practice of employers avoiding paying “benefits”, such as vacation pay, health insurance, “over-time-pay” and contributing the employer’s part of Social Security and other tax obligations, by “hiring” an “independent contractor”can result in serious consequences including heavy government fines in the thousands of dollars.
Effective January 1, 2012, a new California law – Senate Bill (SB 459) – imposes stiff penalties that range between $5,000 to $25,000 for the “willful misclassification” of independent contractors by employers “avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor.” To read the full text of the bill, SB 459, click HERE.
Introduced by Senator Ellen Corbett (D-San Leandro) and signed into law by Governor Jerry Brown in October of 2011, SB 459 adds Sections 226.8 and 2753 to the Labor Code, relating to employment. SB 459 also imposes joint liability on a person who, for money or other valuable consideration, “knowingly advises an employer to treat an individual as an independent contractor to avoid employee status.” However, this section of SB 459 does not apply to:
- A person who provides advice to his or her employer.
- An attorney authorized to practice law in California or another United States jurisdiction who provides legal advice in the course of the practice of law.
As for monetary penalties, if the Labor and Workforce Development Agency or a court issues a determination that a person or employer has engaged in any violations of SB 459, the person or employer shall be subject to a civil penalty of:
- Not less than $5,000 and not more than $15,000 for each violation, in addition to any other penalties or fines permitted by law.
- Not less than $10,000 and not more than $25,000 for each violation, in addition to any other penalties or fines permitted by law, if the person or employer has engaged in or is engaging in a pattern or practice of these violations.
As previously reported on the ESR News blog ‘California SB 459 Enacts Stiff Penalties for Employers Willfully Misclassifying Workers as Independent Contractors,’ the passing of AB 459 and the growing trend of scrutinizing worker classification relates to the background screening industry since some background screening firms use at-home workers to make verification phone calls that may be misclassified as independent contractors. Employers need to be careful using background screening vendors that rely upon misclassified workers since an audit may adversely impact the ability of the vendor to maintain services.
In his article ‘The Dangers of Treating Home Operators as Independent Contractors,’ Attorney Les Rosen, founder and CEO of nationwide background screening company Employment Screening Resources (ESR) and author of ‘The Safe Hiring Manual,’ reveals that some background screening firms treat at-home workers as independent contractors: “The screening firm often has regular employees at the main office doing the same work, so that the so-called “independent contractors” are doing what regular employees do, but without a regular salary, or any benefits.”
However, Rosen writes that the Internal Revenue Service (IRS) and state agencies “have the authority, which they exercise, to conduct extensive audits of a business to determine if the classification was correct. If the IRS or state agencies determine that workers should have been classified as employees, then the business can be subject to fines, penalties, back taxes, and lawyer’s fees.”
As a result of trying to avoid treating at-home workers as employees, Rosen indicates that background screening firms can [also] potentially face liability for federal and state payroll taxes that should have been paid for misclassified workers, substantial penalties to the IRS or state, fees and damages if litigation is involved, and responsibility for benefits and overtime pay the independent contractors would have received if instead, were classified as employees.
The article ‘The Dangers of Treating Home Operators as Independent Contractors,’ is available by clicking HERE.
Employment Screening Resources (ESR) – a nationwide background-check firm accredited by The National Association of Professional Background Screeners (NAPBS) – does not rely upon home based operators to perform employment and education verifications. To learn more about ESR, visit ESR-CHECK or call toll free (888) 999-4474.
About Employment Screening Resources (ESR):
Founded in 1997 in the San Francisco, CA area, Employment Screening Resources (ESR) literally wrote the book on background screening with “The Safe Hiring Manual” by ESR Founder and CEO Lester Rosen. ESR streamlines the screening process and reduces administrative overhead though its proprietary technology solutions. ESR is accredited by The National Association of Professional Background Screeners (NAPBS), a distinction held by less than two percent of all screening firms. This important recognition was achieved by successfully passing a third party audit demonstrating compliance with the NAPBS Background Screening Agency Accreditation Program. By choosing an accredited screening firm like ESR, employers know they have selected an agency that meets the highest industry standards. For more information about ESR, click ESR-CHECK or call toll free (888) 999-4474.
Employers and other interested parties can subscribe to “on-line” news about these issues through:
The Employment Screening Resources (ESR) News blog – ESR News – provides employment screening information for employers, recruiters, and jobseekers on a variety of topics including credit reports, criminal records, data privacy, discrimination, E-Verify, jobs reports, legal updates, negligent hiring, workplace violence, and use of search engines and social network sites for background checks. For more information about ESR News or to send comments or questions, please email ESR News Editor Thomas Ahearn at email@example.com.
Source Credit: ERS NEWS
While “avoiding employer taxes and other employer obligations” may be a viable means of reducing business operating costs and yet provide additional “staff” to help the business prosper, there are some serious tactics to consider before “hiring an independent contractor”.
A complex “contract” between the business (the “employer”) and the party who provides the service (independent contractor) need not be “complex” at all. In fact, the “contract” may be verbal — but a written agreement stands much taller in a courtroom challenge.
The “independent contractor” concept is really quite simple. First, let’s define that an independent contractor is NOT the same as a tradesman being required to posses a state issued “contractors license” such as for electricians, plumbers, roofers, painters, etc.
Think of you, a homeowner, as entering into a contract/agreement with a roofing company to repair or replace the aged roofing on your house. The “roofer” states a fixed price for the job, and some kind of “time” in which the job will be completed. You agree and sign the “contract”.
You, the buyer of the goods and services from the “roofer”, does NOT dictate how the roofer does the job, what time, when they take a break or lunch, what they wear…. you get the picture. You are not an “employer” and the roofer is not an “employee”.
When the job is complete, the “roofer” (an “independent contractor”) issues you an INVOICE you are obligated to pay for the goods and services rendered; the roofing job.
You pay the invoice and the contractor goes on with life providing goods and services to others. Clearly, that is an indication the “roofer” is factually an “independent contractor”.
Let’s use another example:
Your business, is a facility that manufactures and sells simple wood toys for tots. One of your main pieces of heavy equipment in your small factory breaks down and may be months before it gets fixed or replaced.
You, the business person, ”farm out” (hire a woodworker) part of your manufacturing process to someone to produce certain “toy parts” you can no longer produce. Turns out the guy you deal with works out of his home and is currently not “in the business” of producing anything except for his “hobby” woodworking, but, could use the extra income.
You, the toy making business, have other actual, regular employees for the main business operations. You and the hobby woodworker come to some mutual agreement to produce a certain quantity of “toy parts” at a fixed price and you’ll provide the “hobby woodworker” with all the materials, details, drawings, etc. needed to produce the parts.
You two, enter into (sign) an agreement — nothing elaborate, just a simple agreement. You specify, in the agreement, that you want 1,000 parts, done to your specifications (drawings) and you’ll provide him with the raw materials. “Hobby Woodworker” agrees to produce the parts within 3-weeks time from receipt of the raw materials.
You deliver to Hobby Woodworker the materials, Woodworker produces the finished parts in the time agreed on. Job is finished.
You then write a company check to Woodworker for the amount of money you agreed upon (or pay ‘em cash) and Woodworker goes back to doing his hobby stuff.
This is clearly an “independent contractor” relationship, not an employee. The Woodworker is 100% free to do the job in any manner he chooses, works any hours he chooses and is 100% responsible for anything and everything concerning government regulations, taxes, licenses, noise, dust… what ever.
Here’s a slightly different example that is likely to be challenged as to whether or not the “worker” is an independent contractor or actually (under law) an “employee”.
For this example, we’ll change the previous scenario slightly – your equipment isn’t broke, and is currently operated by one of your employees. But, you have need for the extra quantity of parts to fill “holiday orders”. Your equipment can only produce so many pieces in an 8-hour day, your current employee is already doing overtime and to hire another full time employee for a couple weeks does not make financial or fiscal sense.
Hobby Woodworker is contacted to help produce these parts for the toys. Woodworker agrees to come to your factory, only on weekends (when you are normally closed), uses your equipment and materials to produce the agreed upon quantity of the parts. You and Woodworker agree on a specified amount of money as payment for his services – say, $0.50 cents per piece – a piece rate. You pay him weekly (or even monthly) over a period of, let’s say, 7 months. You provide Woodworker with a key to your facility and allow Woodworker to set his own hours. Woodworker performs as agreed upon and you pay him the agreed upon “payment for services” on a somewhat “regular” basis. Hobby Woodworker is NOT an “independent contractor” under these conditions.
This relationship can be successfully challenged and declared as an “EMPLOYEE” relationship. Why? Because Woodworker does not have an active business, a business license (if required), and that he is required by you, to perform all the work using your materials and equipment on your premises and only on weekends, and that you pay him on a “regular time basis” such as weekly or monthly and Woodworker (not normally “in business”) does not have “invoice” forms, does not issue you an invoice for the services rendered.
In this case, “if it looks like an employee, acts like an employee, gets paid like an employee, Woodworker must be an employee.”
Even though the “job” lasted for just 7-months, and you did not dictate Woodworker’s hours (but you did dictate “only on weekends”) or when he can take a break, go to lunch and so-on, Woodworker was required to do the work IN your factory and use your equipment and materials. Woodworker is not otherwise “in business” and issues no ”invoices” but gets paid by you on a “regular basis”. Woodworker IS an employee.
Let’s look at a slightly different scenario.
You own and operate a small retail store and have two regular employees. The holidays are approaching and you have an idea on advertising through the mail your “holiday specials”. You’ve gone to the printer, who produced the advertising pieces. You paid for the stuff and carry it home, intending on putting it all together, addressing each one making them ready to mail… but time and energy is not on your side.
You chit-chat about your clever advertising idea with a neighbor, a close friend and confidant, Jackie, who is a regular “stay-at-home” Mom and is not employed. In the chat Jackie suggests she could help with assembling the ad pieces (from the printer) and even addressing the stuff for you, to help you out.
You think that’s a great idea, and offer her, say, $200 if she can complete the assembly and addressing in two-weeks time. Jackie accepts your offer. You give Jackie all the materials, instructions on how the printed ad pieces should be assembled and a list of mailing addresses.
Jackie accomplishes the job in less than two-weeks. You gather up the “finished project” and head off to the post office where the project is mailed to your intended recipients. You give Jackie $200 in cash, the agreed upon amount for completing the job.
Is Jackie an “independent contractor?” YES she is. What ever legal responsibilities Jackie has regarding the “income” of the $200 is hers alone to deal with. Can “you” deduct that $200 as a “business expense”? YES. However, you “could” be required to provide proof of the expense if audited.
If you are audited and the $200 “expense” is challenged, you, (in the scenario given) have absolutely zero “proof” or “evidence” the $200 was ever paid out as an expense. Therefore, in “any” similar event where you simply paid cash for help on a “one-time” project, you are advised to use some simple “handwritten” agreement about the project showing your business name (etc) and Jackie’s full name, address (etc) and the agreed upon amount of money to be paid on completion. Later, Jackie should sign that “document” as having received the payment, on completion.
Should your “expense” be challenged in an audit, you have the “document” as your “evidence” of that expense. Beware however. If this same scenario is repeated on, say, a weekly, monthly or any other frequent regular appearing basis, it “could” be challenged as an EMPLOYER / EMPLOYEE relationship unless there is a clearly defined written contract between you and Jackie as to what, when, where, and how much $$ is involved in an “independent contractor” relationship. In this case, pay Jackie by check, not cash.
One last example of the above “advertising mailing” project that will upset the apple-cart.
All of the details in the above example remain the same except we will inject a quirk that could result in Jackie being declared an “employee”.
You still have two regular employees in your retail store. Because you have more than 6,000 advertising pieces to be mailed out in 2-weeks, Jackie, you neighbor, cannot do all 6,000 and meet the deadline. So, you instruct one of your regular employees to assemble 2,000 pieces during her regular work hours at your store. You give Jackie the remaining 4,000 pieces. Both your employee and your friend and neighbor Jackie are tackling the same project.
Jackie CAN be classified as an EMPLOYEE on grounds you already have “staff” providing the same work services at your store AND added Jackie to the mix in order to meet a mailing deadline. Each of the two are performing the same task.
While Jackie was not “hired on as an employee” at the store, even temporarily, performing a work task from her home almost exactly the same as your regular employee “at” the store makes Jackie’s efforts look like she’s an employee.
Now, given that Jackie’s “part” of the project has never happened in the past, is a “one-time-project” performed on her own time, in any manner she chooses, for an agreed upon “fixed” fee, and does not utilize any of the store’s resources, her participation in this “one-time-project” may well meet the “independent contractor” status — but it “is” walking on a thin line when it comes to government “interpretation” of the letter of the law.
If this project was a kind of project that could not physically be accomplished by the store’s regular employee(s) due to space, the type of labor, or some other characteristic, the ”independent contractor” status of Jackie may hold up — especially if there is a written agreement. But if Jackie does a similar job 3,4,5-times a year…. look out as Jackie’s “independent contractor” status might well be challenged.