Summary: Last week, the California Legislature passed SB 459, known as the “Worker Misclassification” bill. This bill prohibits the willful misclassification of individuals as independent contractors and imposes penalties of between $5,000 and $25,000 per violation. In addition to these monetary penalties, violators are branded with a “scarlet letter” requiring them to prominently display a notice of the violation on their website, which must remain posted for one year.
Additional Details: What is a “willful” violation? The term “willful” is typically interpreted to require an intentional act or omission, and is defined in the bill as “avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor”. Additionally, the bill provides penalties for employers who make deductions from compensation to misclassified independent contractors that would not be allowed if the individual was an employee (for example, charging for materials, space rental, repairs, etc.).
The Legislature was likely motivated in part by the desire to recapture some of what is estimated to be billions of dollars in lost revenue from the misclassification of employees as independent contractors. Opponents of the bill (the California Chamber of Commerce and other employer-based organizations) call it a “job-killer” and argue that it creates an additional hazard for employers in attempting to navigate the murky waters of classification.
With this new bill, expected to be signed by the Governor in the next 30 days, the potential cost of misclassifying employees as independent contractors ratchets up another few notches — starting at $5,000 to $15,000 per violation and increasing to $10,000 to $25,000 per violation where the employer is found to have engaged in a “pattern or practice of violations”. Therefore, it is more important than ever to for employers to have a classification process in place that they can rely on to establish that they did not “willfully” violate the law.
Advice to employers: This new bill provides yet another indication of both the federal and state government’s intention to look to independent contractor misclassification as a source of revenue. Employers can provide an additional layer of protection from this liability by outsourcing the classification function to a reputable and knowledgeable third party, taking it out of the hands of hiring managers or others who may lack this specialized training and may be viewed as acting in their employer’s economic interests (and not considering the situation through an objective set of eyes).
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WATCH OUT – California Targets Independent Contractor Misclassification with New PenaltiesSeptember 23rd, 2011Misclassification Is Not Always IntentionalMay 3rd, 2010A friend and I were talking the other day about how she had just visited a client who thought he was taking on his proper worker classification duty by the horns. The client had advised my friend that he was being vigilant when bringing aboard independent contractors. For the most part, the client was sending questionable independent contractors directly onto someones payroll. However, there were a few instances for which the client had taken the liberty of approving a worker’s independent contractor status. The workers whom he had been evaluating were set up as legitimate businesses, had significant investment in business, were paid on milestones, and the projects were relatively short term with little-to-no control. What the client wasn’t taking into account was that they were the independent contractor’s first and only source of revenue. Therein lies the problem. I’m not going to turn this blog into a public service announcement denouncing all independent contractors who are just starting out. Unfortunately they serve as just one example of how classifying workers is no easy task. Put yourself in this position: you’ve engaged a independent contractor for a short term project. Business continues to grow and before you know it, that initial three month project has turned into a nine month project. The independent contractor knows they’ve got a pretty nice gig, so there’s little chance that he/she is going to decline the extension. What could have potentially been a small percentage of the independent contractor’s income for the year has now turned into something bigger. Fast forward to the end of the project and the independent contractor finds themselves without another gig on the horizon. Days and weeks go by without work so what happens next? They have to pay bills so what do they do? They file for unemployment. Was the decision of the worker premeditated? Most likely not. Could it lead to an inquiry by the IRS or EDD? I wouldn’t bet against it. This is an example of a problem that could arise when dealing with any independent contractor, let alone a first time contractor. I would even go as far as to say that the example I have provided was somewhat extreme since I’ve rarely crossed paths with an independent contractor who was truly set up as a business or was being brought on to perform a project that was free from control. You could even swap out the unemployment portion and replace it with workers compensation and it would still draw interest from the government. So what’s the point to all of my babble? No matter how closely you’ve examined a worker and provided them with independent contractor status, it’s still out of your hands. You can only do so much to prevent an independent contractor audit. Whether the worker conducts themselves like a true independent contractor is a whole different story. I’ve used the examples of an independent contractor filing for unemployment and workers compensation. Not only does a company have to worry about those issues but also whether or not the independent contractor is filing his/her taxes. When does the worrying end? With so much to think about, I can see why companies hire part-time workers or utlilize third party agencies to payroll all non- employee workers: independent conractors or not. When speaking to clients, rarely have I encountered a company who didn’t want to do the right thing when it came to worker classification. Unfortunately, when companies let their guard down, audits strike. I used the conversation between a friend and I because I thought it summarized how most companies handle their independent contractor classification dilema. Whether you perform independent contractor evaluations yourself or outsource it to a vendor, no company thinks that a “harmless” company decision will ever land them in an audit. Wishing Away an IRS Audit: 1099 Worker MisclassificationDecember 22nd, 2009With worker misclassification issues at the forefront and landmark cases paving the way for added legislation, fines and penalties for improperly classifying workers, it’s surprising that intelligent business leaders still believe they can simply wish away federal or state audits. And it’s alarming that many businesses are still operating without solid processes in place to ensure compliance when engaging 1099 independent contractors. Given the extreme tax liability of engaging 1099 workers, business leaders shouldn’t assume they’re safe from an audit. Corporate counsel, human resources managers, procurement leaders, CFOs and others in a position of decision are constantly exposed to information on the risks of misclassifying workers as independent contractors. And still, there’s a propensity to believe they won’t be audited: “Yeah, it may be happening to others, but there’s no way it’ll happen to my company.” Worker Misclassification Under Scrutiny The IRS announced it will conduct 6,000 additional audits in 2010 starting in February. What’s the motivation? It’s estimated that the government is losing billions and billions of dollars in unpaid taxes due to the misclassification of employees as independent contractors. As a senator, Barrack Obama co-authored legislation to remove the last loophole in the IRS tax code, Section 530 of the Internal Revenue Service Act of 1978—a clause the IRS must consider in a 1099 audit that can potentially preclude an employer from paying back taxes, penalties and fines for misclassifying workers. Currently, there is no reason to think that our new president will move away from this effort given three primary drivers: 1. The government wants and needs the unpaid tax dollars There has been more legislation proposed or passed in the past two years regarding worker misclassification than ever before. And conventional wisdom suggests that the effort to crack down on employers will continue to escalate. Recent legislation has significantly increased the penalties and fines associated with misclassification and in some cases, include felony charges and losing the right to operate a business. A plethora of court rulings exist against employers who misclassify employees as ICs. While many employers are unintentionally misclassifying workers, they still face stiff punishment from failing an audit. Those found to be intentionally misclassifying workers can face even greater consequences. Elevated Risk for All Businesses There is far too much evidence that the misclassification issue crosses all segments of business regardless of industry, geography, size and position. It also crosses all divisions of organizations, ranging from customer service, marketing and sales to engineering, information technology and even human resources. Companies should be taking the proper steps in 1099 risk assessment, especially in this economy. The recession has increased an employer’s risk. Why? There are several reasons: • Independent contractors who finish a job or are no longer needed in a market where unemployment is at its highest, file claims for unemployment insurance naming the company they were providing services to as their employer Creating a Proper Worker Classification Process Many companies attempt to build a 1099 process but typically don’t have the expertise. Or they simply cannot stay current with ever-changing legislation. To complicate this further, the various state and federal agencies that audit an employer’s 1099 relationships use different tests. They can range from the IRS 3 factors/20 questions test to common law, ABC, relative nature of work, FLSA’s economic realities test and many more. The issue of employee misclassification is clearly approaching top of mind with legislators, government agencies, courts and ethical businesses. The use of independent contractors is growing as well. The combination of the two will inevitably result in greater scrutiny, audits, penalties and fines. Business leaders: It’s time to stop wishing and take action before action is taken on you. Create your corporate 1099 compliance plan before it’s too late.
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