Independent Contractors

In the early stages of establishing a new company, employers often experience a period of sticker shock when seeing what is factored into the the total costs of hiring an employee. From recruitment fees to workers comp and payroll taxes, the costs stacked on top of the wages can add up quickly. However, when properly handled, the use of independent contractors can be a very clear and concise way to get work done. Since an independent contractor is a non-employee, businesses can take advantage of this fact to avoid paying payroll taxes, benefits and workers comp.

The number one misconception about independent contractors, or "1099 workers" as they're sometimes called, is that the employer can choose to pay anyone in this manner. In reality, the determination of who can be called an independent contractor is managed by a number of government agencies, like the Employment Development Department (EDD), which is concerned with employment-related taxes, and the Division of Labor Standards Enforcement (DLSE), which is concerned with whether the wage, hour and workers’ compensation insurance laws apply. So what is an independent contractor? There are a number of factors that are considered, but basically think of it as someone who makes a living doing a particular task for multiple clients that isn't part of the core business of those clients, like a legal consultant for a flower shop. Here's a more thorough list of what is considered:

  • Whether the person performing services is engaged in an occupation or business distinct from that of the principal;
  • Whether or not the work is a part of the regular business of the principal or alleged employer;
  • Whether the principal or the worker supplies the instrumentalities, tools, and the place for the person doing the work;
  • The alleged employee’s investment in the equipment or materials required by his or her task or his or her employment of helpers;
  • Whether the service rendered requires a special skill;
  • The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;
  • The alleged employee’s opportunity for profit or loss depending on his or her managerial skill;
  • The length of time for which the services are to be performed;
  • The degree of permanence of the working relationship;
  • The method of payment, whether by time or by the job; and
  • Whether or not the parties believe they are creating an employer-employee relationship may have some bearing on the question, but is not determinative since this is a question of law based on objective tests.
The most important thing to notice in the list of criteria is that the court does not feel that intention is very relevant in determining the outcome. Instead, the classification of who is an independent contractor is based on objective tests. In other words, the status of independent contractor isn't something that can be changed by intention or agreement between the parties.

The California Supreme Court applied this "economic realities" test in S. G. Borello & Sons, Inc. v Dept. of Industrial Relations (1989) 48 Cal.3d 341. The main factor in that case centered around the question of who was basically in control of the worker and the work being done. If the business could decide what work is to be done and how it is to be done, then the facts would lean in favor of the worker being an employee instead of an independent contractor. In other words, if you do things like have a set schedule, required format or method for the work, then you might actually have an employee on your hands. That employee would then be entitled to all the rights of other employees, like overtime and payroll tax contributions from their employer. That means you could be on the hook for some hefty back-payments and possible penalties!

What do you do then if you've already got "1099 workers" but aren't sure whether you're in compliance? The bad news is that correcting the misclassifications won't erase your exposure to all of the liabilities for the time that they were improperly paid, but you will be able to prevent that liability from growing. Moreover, the IRS has recently instituted a Voluntary Classification Settlement Program to limit their past federal employment tax liability for current workers they are treating as non-employees by reclassifying them for future periods and paying a small percentage of the taxes owed in the current period.

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