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The Dangers of Misclassifying Your Workers

Emilie K Elliott square2

Employers are often confused about what makes a worker an employee rather than an independent contractor. The distinction is of great importance, as misclassification can lead to litigation by, and damages owed to, a number of different players, including the employee, the IRS, the FTB and the Division of Workers Compensation.

What makes a worker an employee? It really comes down to the degree of control exerted by the employer over the employee in terms of the manner and means of accomplishing the work. The more control exerted by the employer, the more likely the worker, regardless of how he or she is classified, is actually an employee. This is a fact-intensive inquiry, and there are very few “bright line” rules – which is part of the reason the correct characterization is so important and lends itself to litigation.

Other important and relevant factors are the degree of integration of the worker into the employer’s business, whether the worker uses his or her own tools (computer, desk, telephone, etc.) or whether such tools are supplied by the employer, whether the work performed is part of the regular business of the employer, where the individual performs the work, whether the services he or she provides require a special skill, the worker’s opportunity to profit or lose depending on his or her managerial skills, the length of time and degree of permanence of the working relationship and whether payment is by the amount of time spent or by the job. All of these factors bear on whether a worker appears to be running his or her own business (i.e., like an independent contractor) or, alternatively, whether the worker is actually a part of the employer’s business (i.e., like an employee).

Often, employers and workers think that, because they memorialize in an agreement that they are in a certain kind of relationship (independent contractor or employee), they are “in the clear,” but this not necessarily true. Although the parties’ intention (and their relative negotiating power) has some bearing, the relationship still has to be bona fide, and the actual effect of the agreement must look and act in accordance with what the parties say it is. Otherwise, a court or other interested entity may seek to void your stated characterization, and a number of consequences could flow from this.

Speaking of interested entities, a number of government agencies are interested in whether a worker is misclassified. These entities include, but may not be limited to, the IRS, the Division of Labor Standards Enforcement (DLSE), the Employment Development Division (EDD), the Division of Workers’ Compensation (DWC) and the Franchise Tax Board (FTB). Adding to the confusion and uncertainty, one entity’s determination that a worker is not misclassified is not binding on the other entities. Thus, although an employer may escape penalties with the DLSE, the same employer may be required to back pay payroll taxes with the FTB or IRS if a worker is later determined (by those agencies) to be an employee rather than an independent contractor.

Other consequences of misclassification by an employer include, but are not limited to, having to pay the worker for unpaid and unknown overtime and the associated penalties plus interest, meal and rest break penalties, waiting time penalties (for not paying all amounts due within 72 hours of termination, even though, at the time, the employer did not know the employee was misclassified), wage statement penalties, workers’ compensation fines, IRS and FTB fines and penalties, and, potentially, class action exposure.

Employers can’t afford to get this wrong! Misclassification can lead to severe consequences for an employer. If you have questions about the proper classification of your employees, or any other labor and employment law questions, please contact Emilie Elliott at eelliott@carnaclaw.com, or at 805-546-8785. The attorneys at Carmel & Naccasha have extensive experience in handling matters related to labor and employment law on behalf of employers and public agencies and are happy to assist you.