Independent Contractors - California & Federal Law
There is a difference between hiring an individual as an independent contractor or employee. Independent contractors and employees require employers to file different tax forms (ie. 1099-MISC), withhold different amounts from paychecks, and pay a different amount in taxes. Using a true independent contractor can relieve you of the many burdens placed upon you by California and federal employment laws, but simply calling someone an independent contractor does not make him or her one in the legal sense.
General Issues with Independent Contractors
Before classifying an individual as an independent contractor, familiarize yourself with the many factors the different governmental agencies use to determine independent contractor status.
Many employers operate under the misconception that they will be safe from the significant penalties of misclassification if their relationship meets certain conditions. This simply is not the case.
- Classifying an individual as an independent contractor vs. employee.
California Common Law Test
California courts and administrative agencies have generally applied common law principles to determine independent contractor status, since the law does not specify criteria for such determinations.
The most important factor in that determination involves the independent contractor's right to control the manner and means of accomplishing the desired result, even if the contractor does not exercise that right with respect to all details.
The California Supreme Court discarded the common law test as the sole means of determining independent contractor status in relation to workers' compensation coverage. The court applied six additional factors federal authorities use as well as the right-to-control factor.
Therefore, this decision affects independent contractor status not only for workers' compensation purposes but for other employment-related claims as well. As a result, there has been a decrease in the number of independent contractor relationships upheld by the courts and administrative agencies.
Federal Taxes and Independent Contractors
The IRS is the federal taxing authority that determines whether an employment relationship exists between a worker and employer that requires payment of federal employment taxes, including Social Security taxes, payment under the Federal Unemployment Tax Act and withholding of worker-owed employment taxes.
Misclassification of bona fide employees as independent contractors may result in the federal government collecting significant financial penalties from employers and the IRS aggressively auditing companies to expose abuses. It is estimated that as much as $1.5 billion in income, Social Security withholdings and unemployment tax revenue is lost annually due to misclassification of as many as 3.5 million workers as independent contractors. Companies judged by the IRS to have misclassified employees as independent contractors face not only large government fines but also payment of employment taxes.
Wages and Hours
The true nature of the relationship between a wage claimant and a purported employer is addressed by the California Labor Commissioner when the issue of independent contractor status is raised in a wage claim or audit proceeding. Labor Commissioner's hearing officers and auditors use the right to control as well as other factors in making determinations of employee or independent contractor status.
Independent Contractor Reporting Obligations
All businesses and government entities that hire independent contractors must file reports with the state Employment Development Department.
The Law Explained
The independent contractor reporting program is designed to locate parents who are delinquent in their child support obligations. Businesses operating outside California are subject to this law. For example, an independent contractor who works in California for a business based in Texas must be reported to California's EDD.
There is a penalty for each instance of late filing or failure to file the Report of Independent Contractors, unless there is good cause. The penalty increases if there is a conspiracy between the hiring entity and the independent contractor not to supply the required report or to supply a false or incomplete report.
HRCalifornia members have access to several tools and services that help those who manage human resources to work through Independent Contractor-related issues, including:
Any business or government entity that is required to file a Federal Form 1099-MISC for service performed by an independent contractor must report using this form.
Review this table for IRS, EDD/FTB, INS, workers' compensation, US DOL, and California Labor Commission definitions of an independent contractor.