Independent Contractor or Employee? Federal and California Law
Who controls the work? The general rule is that a person is an independent contractor if the employer has the right to control or direct the RESULTS of the work but not HOW the work is done or even WHAT work is done.
Many employers misclassify workers as independent contractors and pay them as "1099 employees" when in fact they should be classified and paid as regular W-2 employees. Employers receive a substantial benefit from doing this, but there is NO benefit to the workers. If a worker is wrongly classified as an independent contractor instead of an employee, that worker will not be eligible for many benefits of employment or eligibility will be reduced. Areas affected include the right to:
– be paid for all hours worked or controlled by the employer;
– the legal minimum wage;
– overtime pay;
– rest and meal breaks;
– workers' compensation insurance;
– Social Security contributions;
– unemployment benefits;
– state disability benefits;
– employer benefits such as vacation, sick leave, pension, medical insurance, etc.
Also, in some states, including California, employers are subject to a penalty if they misclassify employees as independent contractors (see below).
There are different ways to determine if a worker is an employee or independent contractor. Employers must comply with all relevant laws.
FEDERAL TAX LAW: The Internal Revenue Service (IRS) looks at three areas to determine a worker’s status:
Behavioral Control – This area considers instructions and training. If the employer has the right to direct or control the work, even if it does not exercise that right, the worker is an employee. These instructions might include when to do the work, or how and where to do it; what equipment or tools to use; who the worker can hire or not hire to help get the work done; what supplies and services to buy, and/or where to buy them. If the employer trains the worker in required methods of doing the work or the procedures to get the work done, this is evidence the employer wants things done its way, which indicates the worker is an employee and not an independent contractor. Therefore, if the employer gives the worker detailed or extensive instructions on how to get the job done, the worker is probably an employee and not an independent contractor.
Financial Control – This area considers who has the right to direct and control the business, not just the work. The more of a financial or promotional investment the worker has made in the work, the more likely the worker is an independent contractor. However, there is no requirement for an investment in order to meet the definition of independent contractor. If the worker incurs expenses in performing the work but is not completely reimbursed, the worker is more likely to be an independent contractor rather than an employee, especially if these expenses are high. If the worker has the chance to make a profit or loss on the work, the worker is probably in business for himself or herself and therefore an independent contractor.
Relationship of the Parties – If the worker does not receive benefits such as medical coverage, vacation, or pension, the worker may be an employee or an independent contractor. However, if the worker receives benefits, the worker is probably an employee.
If the worker is an employee, the employer must withhold income tax and the employee’s portion of Social Security and Medicare taxes. The employer must pay Social Security, Medicare and unemployment (FUTA) taxes on the wages the worker earns. The employer must give the worker an IRS Form W-2, Wage and Tax Statement, every year showing the amount of wages paid and taxes withheld from the worker’s pay. As an employee, the worker has the right to deduct unreimbursed business expenses from the worker’s taxes on IRS Schedule A if the worker itemizes deductions and meets the other requirements established by the IRS.
If the worker is an independent contractor, the employer must give the worker an IRS Form 1099-MISC Miscellaneous Income to report what it has paid to the worker. The worker must pay his or her own income tax and self-employment tax, and may be required to make estimated tax payments during the year. The worker can deduct business expenses on IRS Schedule C of his or her income tax return.
The main test in California is who has the right to direct and control the “manner and means" in which the job is performed. This is similar to the IRS’ Behavioral Control described above. California then looks at secondary factors, which include:
Are the services provided on a long-term or repeating basis? Is the worker paid based on the time spent working? Are the services an integral part of the employer’s business? Does the employer establish the work hours? Does the employer determine how many hours will be worked? Does the employer dictate the order in which job tasks are to be performed? Does the worker spend all of his or her time working for one employer? Is the worker supervised? All of these factors tend to show the worker is an EMPLOYEE.
Is the worker in a distinct occupation or trade? Are the worker’s services available to the general public? Can the worker hire, supervise and pay assistants? Did the worker make a substantial investment in facilities or services? Does the worker do the job without supervision? Is the worker highly skilled or working in a specialized field? Does the worker supply the tools and other materials used to do the job? Does the worker provide the location in which the work is performed? Is the worker paid at the end of the project? All of these factors tend to show the worker is an INDEPENDENT CONTRACTOR.
Also under California law, an employer can be fined for “willfully misclassifying" an employee as an independent contractor. The amount of the fine ranges from $5,000 to $15,000 per violation. If there is a “pattern and practice" of willful misclassification, the fine can increase to $25,000 per violation.