It is not uncommon for business owners to avoid paying taxes and employee benefits (i.e. overtime pay) by hiring independent contractors instead of employees. These business owners are already at risk of an audit by the Employment Development Department and the IRS. If the audit ends up in a reclassification, the business owner will be responsible for unpaid taxes, possible penalties and interests. Now, as a result of new California legislation, this practice of misclassifying workers can end up costing business owners and their advisers everything.

  • S.B. 459

As of January 1, 2012, the California Legislature enacted a harsh new law targeting the misclassification of workers as independent contractors by California business owners. Under S.B. 459, a business owner can be found to have engaged in the following unlawful activities: 1. The "willful misclassification" of an individual as an independent contractor and/or 2. Charging a willfully misclassified worker a fee, or making any deductions from compensation for any purpose that would have violated the law governing deductions from pay (Labor Code sections 221 and 224) had the worker properly been classified as an employee.

Additionally, non-lawyer consultants are subject to joint liability for knowingly advising a business owner to classify a worker later determined to be an employee.

  • Penalties

This laws allows California's Labor Commissioner or a court to levy a civil penalty of $5,000 to $15,000 for each violation found "willful." If it is also determined that the business owner engaged in a pattern or practice of "willful misclassifications" a civil penalty of $10,000 to $25,000 may be imposed. Additionally, this law also empowers the Labor Commissioner to assess additional damages of behalf of those misclassified (the workers themselves). As a result, if a business owner misclassifies a large group of workers as independent contractors, the business owner may be subject to a class action law suit by this group.

  • "Willful"

The key word here is "willful". "Willful misclassification" is defined as "avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor." Although this standard appears to be more stringent than the "voluntary and intentional" standard proposed in earlier versions of the law, it is still problematic because courts have defined "knowing" to included constructive knowledge. As a result, if it is found that the business owner should have known that the worker should have been classified as an employee, the misclassification will be found willful. This is a very vague and subjective standard that will cause a lot of uncertainty and is unlikely to protect business owners who are simply mistaken about the proper classification.

  • Notice

In addition to the penalties, the law also requires the business owner to post a notice (either on its website or place of business accessible to all employees and the general public) at each location where a violation occurred. This notice must contain the specific information about the violation, be signed by an officer and be posted for one year. In sum, this new law imposes potentially crippling and humiliating penalties upon California business owners who improperly classify their workers. Since the standards for determining whether a worker is an independent contractor or an employee are also often subjective, this law will likely excessively burden California business owners. If the goal of the California legislature is to inflict fear in California business owners and thereby do away with most independent contractors, the new law will most likely succeed.