Are You Hiring an Employee or an Independent Contractor?

When hiring new workers, it’s important to understand what signifies an employee verses an independent contractor. For the purpose of wage and hour laws, there is no single, defining factor that determines this classification. Many factors exist, and it is common for worker classification to vary based on the scenario.

Multiple California agencies play a role in determining worker status. The Employment Development Department (EDD) administers California’s employment tax laws. The Division of Labor Standards Enforcement (DLSE) determines how wages, hours, and worker’s compensation insurance laws apply to workers. In addition, other state agencies also enforce independent contractor regulations. These include the Franchise Tax Board (FTB), as well as the Contractors State Licensing Board (CSLB).

Incidentally, state and federal laws that govern workers can sometimes differ. For example, in some cases it is possible for a worker to be classified as an employee under one law, and be classified as an independent contractor under another law. Unfortunately, misclassifying an employee as an independent contractor does occur often. As a result, businesses may fail to pay wages and overtime, or related taxes including payroll taxes, unemployment insurance, or social security. In addition, other law requirements may have been ignored, including insurance mandates, meal or rest break requirements, or job-related expense reimbursements. For these reasons, it is critical for businesses to thoroughly understand worker classification differences, as failure to do so could result in tax liabilities and penalties, which ultimately put your business at risk.

The most decisive factor in determining worker classification is the right and direction of control. This control may be determined on either a state or federal level. In California, the right to discharge an employee at will, and without cause, is a strong indicator the principal possesses the control in the working relationship. When it is not clear which party possesses control, other elements of the working relationship must be considered. As a secondary measure, California uses a common-law test to help make the determination. Answering “yes” to the majority of these questions may indicate the worker is an independent contractor:

1. Is the worker involved in services, or an organization distinct from your business?
2. Is the work being performed an integral part of your regular business?
3. Has the worker supplied the tools, materials, and location needed to accomplish the work?
4. Do the services rendered require a highly specialized skill set, or particular occupation?
5. Does the worker operate in a geographic location distinct from your place of business without supervision?
6. Are the services rendered for the long-term, or on repetitive basis?
7. Do all parties concur on the nature of the working relationship?
8. Does the worker regard his / her services as an entity separate from your business?
9. Method of payment: Is the worker paid based on project completion, or an hourly wage?
10. To what extent do you (as the business owner) control the working relationship?

On a federal level, the IRS (www.irs.gov) uses a traditional 20-point checklist of questions. Many of these questions are the same as the California common-law test questions. Recently, however, the IRS has condensed its 20-point checklist into a test that examines control in three different areas:

• Behavioral Control: Who controls what work will be done, and how it will be done?
• Financial Control: Who controls the business aspects of work? How the worker is paid? Is the worker reimbursed for expenses? Does the worker make the investment for his / her own tools and equipment?
• Relationship of the Parties: How is the working relationship defined? Does the principal provide employee-type benefits? Are the services rendered as integral part of the principal’s business?

As it stands, there’s not a simple, surefire way to determine worker classification. The decision making process requires thought, research, analysis, and oftentimes tax and / or legal counsel. It is an important decision for employers and business owners to make, and what may be relevant in one situation may not transcend into the next. Businesses must weigh all factors, as no single factor stands alone in the decision making process. Key things to consider are the working relationship in its entirety, and the varying degrees of control in relevant scenarios.

The LaborLawCenter™ understands the complexities employers and business owners face when determining worker classification. For this reason, we provide a comprehensive online resource that presents timely workplace topics that directly pertain to your important business decisions. Whether you operate a California Business, or a business in another state, turn to the LaborLawCenter™. We have the have the tools, kits, and products you need to satisfy your most complex compliance requirements.

This article does not serve as legal guidance. Employers and business owners should consult legal or tax counsel to best understand how wage and tax laws affect business decisions regarding worker classifications.