Independent Contractor vs. Employee Classification: Legal Challenges and Solutions

Using independent contractors as part of the workforce can come with numerous benefits for a business. However, it’s essential for employers to understand that there is a legal distinction between independent contractors and employees. Not only can employee misclassification harm a company’s bottom line, but it can also impact morale and strain relationships with contractors, clients, and customers. Companies must classify workers correctly to avoid incurring reputational damage, monetary penalties, and various legal consequences.

What is the Difference Between an Independent Contractor and an Employee?

An independent contractor is someone who is in business for themselves, while an employee works for and under the supervision of a company. Typically, independent contractors engage in work for many different companies on a short-term basis, in contrast with an employee who agrees to work on a regular and ongoing basis for a single company.

In September 2019, AB5 was signed into law to address the employment status of workers in California. Under AB5, a specific test must be applied to determine whether a worker in California is an employee or independent contractor for the purpose of complying with the Labor Code, the Unemployment Insurance Code, and the Industrial Welfare Commission wage orders. This test assumes that a worker is an employee unless the company is able to establish three elements:

1. The worker is free to perform services without the control or direction of the employer.
2. The worker is performing work tasks that are outside the usual course of the company’s business activities.
3. The worker is customarily engaged in an independently established trade, business, or occupation that involves the same type of work they are performing for the company.

However, it should be noted that there are a number of exceptions to AB5. For instance, the test does not need to be applied to certain licensed occupations, such as physicians, dentists, psychologists, lawyers, engineers, and accountants. It also does not apply in business-to-business contractual relationships or to certain marketing professionals, broker-dealers, human resources professionals, and various other occupations.

What is Employee Misclassification?

Employee misclassification occurs when an employer classifies an employee as an independent contractor, rather than an employee. In some cases, an employer might do this to avoid paying employment taxes. In other cases, an employer might simply fail to understand how to accurately classify a worker. But whether an employer does so inadvertently or on purpose does not matter — regardless of intent, misclassification is always a violation of the law.

Employees usually have stronger job protections and legal rights than independent contractors. When an employee is misclassified, they may be losing their right to minimum wage, overtime pay, sick time, unemployment benefits, vacation time, job protected family leave, and rest periods. Although independent contractors do have certain protections against harassment in the workplace, they generally do not have the same wage and hour protections. However, independent contractors have the freedom to determine their own schedules, set their own fees, and take on as many clients as they wish.

What Penalties Can an Employer Face for Employee Misclassification?

Independent contractors often lack the legal protections of employees when it comes to wages, benefits, and leave protections. Importantly, the laws prohibiting employee misclassification are also meant to ensure employers are complying with their tax obligations. Critically, when employers misclassify employees as independent contractors, they may avoid paying payroll taxes, appropriate wages, and providing workers with the benefits they might otherwise be entitled.

Possible consequences of failing to classify employees correctly can include:

• Employee wage claims
• Owing back taxes and penalties
• Civil penalties of $5,000 to $25,000 per violation
• Financial and reputational harm

In addition to the fines imposed under California law, an employer who misclassifies employees can also face regulatory fines imposed by the Internal Revenue Service (IRS).

How Can Employers Avoid Employee Misclassification Lawsuits?

There are several measures employers can take to avoid employee misclassification lawsuits. Significantly, an employer should work with a skillful employment law attorney who can best advise regarding these matters and assist with implementing appropriate policies that will ensure legal and regulatory compliance. An attorney can help with drafting a clear employment policy and guidelines that are consistent with the law.

An employer should also conduct audits on a regular basis to assess the job duties of workers, the employer’s level of supervision and control, and any other factors that are relevant to worker classification. An audit can include reviewing the records of services provided by independent contractors, verifying whether there are contracts on file for services that are currently engaged, and identifying any areas where improvements can be made.

Additionally, employers should be sure to use a written contract for all independent contractors — not only to define the scope of their services, but also to help verify their classification in the event an audit takes place.

Contact an Experienced California Employment Law Attorney

Correctly classifying an employee versus an independent contractor can be complex. If you are an employer, it’s vital to have a skillful employment law attorney by your side who can ensure you are compliant — and avoid potential repercussions. At White & Bright, LLP, we work with employers to help ensure they understand and comply with the applicable employment laws — and defend them in employee misclassification lawsuits when necessary. We welcome you to contact or call us at (760) 747-3200 to learn more about our legal services