Employee or Independent Contractor?


The determination as to whether a person is an employee or independent contractor is extremely important to both the employer and other person. The determination has substantial tax ramifications for both parties and may determine who has the risk of loss in many situations.

Complicating the situation is the fact that it is possible to be considered an employee by one governmental body and an independent contractor by another.

Any one or more of the following may determine whether a person is an employee or independent contractor:

  • Internal Revenue Service (IRS);


  • Franchise Tax Board (FTB);


  • Employment Development Department (EDD);


  • Division of Labor Standards Enforcement (DLSE);


  • Division of Workers’ Compensation (DWC);


  • Contractors State License Board (CSLB);


  • Uninsured Employer’s Fund (UEF); and / or


  • A court of law.

The test used for federal tax purposes may differ from the test used in a workers’ compensation case or a sexual harassment case.

Due to the high risk of making a misclassification error, and the negative consequences resulting from such a mistake, we urge both employers and those performing work to be conservative in their decision making. An experienced employment attorney with our firm can assist you with all aspects of employment law.

Some of the differences between employees and independent contractors follows:

 

Element or Factor Employee Independent Contractor
     
Employer must make contributions for Social Security taxes Yes No
     
Employer must make contributions for Medicare taxes Yes No
     
Employer must withhold all applicable taxes including state and federal income taxes Yes No
     
File Form 1099 – MISC with IRS if you pay the person $600 or more No Yes
     
Pay for Workers’ Compensation Insurance covering the person working Yes No
Pay into the Unemployment Insurance Fund Yes No
     
Worker is eligible for job benefits such as paid vacation, sick leave, holiday pay, and stock options Yes No
     
Worker is eligible for overtime pay Yes No
     
Employer has the right to control how the worker performs the specific task for which hired Yes No
     
Employer has the right to direct or control how the business aspects of the worker’s activities are conducted Yes No
     

It is easy to understand why employers tend to misclassify works as employees when they are actually independent contractors.

The following information was taken directly

from the Internal Revenue Service:

1. Who Are Employees?

Before you can know how to treat payments that you make to workers for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be:

  • An independent contractor,


  • A common – law employee,


  • A statutory employee, or


  • A statutory nonemployee.

This discussion explains these four categories. A later discussion, Employee or Independent Contractor? (section 2), points out the differences between an independent contractor and an employee.

Independent Contractors

People such as lawyers, contractors and subcontractors who follow an independent trade, business, or profession in which they offer their services to the public, are generally not employees. However, whether such people are employees or independent contractors depends on the facts in each case. The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

Common – Law Employees

Under common – law rules, anyone who performs services for you is your employee if you have the right to control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.

If you have an employer – employee relationship, it makes no difference how it is labeled. The substance of the relationship, not the label, governs the worker’s status. It does not matter whether the individual is employed full time or part time.

For employment tax purposes, no distinction is made between classes of employees. Superintendents, managers, and other supervisory personnel are all employees. An officer of a corporation is generally an employee; however, an officer who performs no services or only minor services, and neither receives nor is entitled to receive any pay, is not considered an employee. A director of a corporation is not an employee with respect to services performed as a director.

You generally have to withhold and pay income, Social Security, and Medicare taxes on wages that you pay to common – law employees. However, the wages of certain employees may be exempt from one or more of these taxes.

Leased employees. Under certain circumstances, a firm furnishing workers to other firms is the employer of those workers for employment tax purposes. For example, a temporary staffing service may provide the services of secretaries, nurses, and other similarly trained workers to its clients on a temporary basis.

The staffing service enters into contracts with the clients under which the clients specify the services to be provided and a fee is paid to the staffing service for each individual furnished. The staffing service has the right to control and direct the worker’s services for the client, including the right to discharge or reassign the worker. The staffing service hires the workers, controls the payment of their wages, provides them with unemployment insurance and other benefits, and is the employer for employment tax purposes.

Statutory Employees

If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute, "statutory employees," for certain employment tax purposes. See an experienced employment attorney for a further explanation.

Statutory Nonemployees

There are three categories of statutory nonemployees: direct sellers, licensed real estate agents, and certain companion sitters. Direct sellers and licensed real estate agents are treated as self – employed for all federal tax purposes, including income and employment taxes, if:

  • Substantially all payments for their services as direct sellers or real estate agents are directly related to sales or other output, rather than to the number of hours worked and


  • Their services are performed under a written contract providing that they will not be treated as employees for federal tax purposes.

Direct sellers. Direct sellers include persons falling within any of the following three groups.

   
1. Persons engaged in selling (or soliciting the sale of) consumer products in the home or place of business other than in a permanent retail establishment.
   
2. Persons engaged in selling (or soliciting the sale of) consumer products to any buyer on a buy – sell basis, a deposit – commission basis, or any similar basis prescribed by regulations, for resale in the home or at a place of business other than in a permanent retail establishment.
   
3. Persons engaged in the trade or business of delivering or distributing newspapers or shopping news (including any services directly related to such delivery or distribution.)
   

Direct selling includes activities of individuals who attempt to increase direct sales activities of their direct sellers and who earn income based on the productivity of their direct sellers. Such activities include providing motivation and encouragement; imparting skills, knowledge, or experience; and recruiting.

Licensed real estate agents. This category includes individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output.

Companion sitters. Companion sitters are individuals who furnish personal attendance, companionship, or household care services to children or to individuals who are elderly or disabled. A person engaged in the trade or business of putting the sitters in touch with individuals who wish to employ them (that is, a companion sitting placement service) will not be treated as the employer of the sitters if that person does not receive or pay the salary or wages of the sitters and is compensated by the sitters or the persons who employ them on a fee basis. Companion sitters who are not employees of a companion sitting placement service are generally treated as self – employed for all federal tax purposes.

Misclassification of Employees

Consequences of treating an employee as an independent contractor. If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker.

2. Employee or Independent Contractor?

An employer must generally withhold federal income taxes, withhold and pay social security and Medicare taxes, and pay unemployment tax on wages paid to an employee. An employer does not generally have to withhold or pay any taxes on payments to independent contractors.

Common – Law Rules

To determine whether an individual is an employee or an independent contractor under the common law, the relationship of the worker and the business must be examined. In any employee – independent contractor determination, all information that provides evidence of the degree of control and the degree of independence must be considered.

Facts that provide evidence of the degree of control and independence fall into three categories: behavioral control, financial control, and the type of relationship of the parties. These facts are discussed below.

Behavioral control. Facts that show whether the business has a right to direct and control how the worker does the task for which the worker is hired include the type and degree of:

Instructions that the business gives to the worker. An employee is generally subject to the business’ instructions about when, where, and how to work. All of the following are examples of types of instructions about how to do work.

  • When and where to do the work.


  • What tools or equipment to use.


  • What workers to hire or to assist with the work.


  • Where to purchase supplies and services.


  • What work must be performed by a specified individual.


  • What order or sequence to follow.

The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved. A business may lack the knowledge to instruct some highly specialized professionals; in other cases, the task may require little or no instruction. The key consideration is whether the business has retained the right to control the details of a worker’s performance or instead has given up the right.

Training that the business gives to the worker. An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods.

Financial control. Facts that show whether the business has a right to control the business aspects of the worker’s job include:

The extent to which the worker has unreimbursed business expenses. Independent contractors are more likely to have unreimbursed expenses than are employees. Fixed ongoing costs that are incurred regardless of whether work is currently being performed are especially important. However, employees may also incur unreimbursed expenses in connection with these services that they perform for their business.

The extent of the worker’s investment. An independent contractor often has a significant investment in the facilities he or she uses in performing services for someone else. However, a significant investment is not necessary for independent contractor status.

The extent to which the worker makes his or her services available to the relevant market. An independent contractor is generally free to seek out business opportunities. Independent contractors often advertise, maintain a visible business location, and are available to work in the relevant market.

How the business pays the worker. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. This usually indicates that a worker is an employee, even when the wage or salary is supplemented by a commission. An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly.

The extent to which the worker can realize a profit or loss. An independent contractor can make a profit or loss.

Type of relationship. Facts that show the parties’ type of relationship include:

  • Written contracts describing the relationship the parties intended to create.

  • Whether or not the business provides the worker with employee – type benefits, such as insurance, a pension plan, vacation pay, or sick pay.

  • The permanency of the relationship. If you engage a worker with the expectation that the relationship will continue indefinitely, rather than for a specific project or period, this is generally considered evidence that your intent was to create an employer – employee relationship.

  • The extent to which services performed by the worker are a key aspect of the regular business of the company. If a worker provides services that are a key aspect of your regular business activity, it is more likely that you will have the right to direct and control his or her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney’s work as its own and would have the right to control or direct that work. This would indicate an employer – employee relationship.

The following information was taken from

the California Department of Industrial Relations:

Not all workers are employees as they may be volunteers or independent contractors. Employers oftentimes improperly classify their employees as independent contractors so that they, the employer, do not have to pay payroll taxes, the minimum wage or overtime, comply with other wage and hour law requirements such as providing meal periods and rest breaks, or reimburse their workers for business expenses incurred in performing their jobs. Additionally, employers do not have to cover independent contractors under workers’ compensation insurance, and are not liable for payments under unemployment insurance, disability insurance, or social security.

The state agencies most involved with the determination of independent contractor status are 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. There are other agencies, such as the Franchise Tax Board (FTB), Division of Workers’ Compensation (DWC), and the Contractors State Licensing Board (CSLB), that also have regulations or requirements concerning independent contractors. Since different laws may be involved in a particular situation such as a termination of employment, it is possible that the same individual may be considered an employee for purposes of one law and an independent contractor under another law. Because the potential liabilities and penalties are significant if an individual is treated as an independent contractor and later found to be an employee, each working relationship should be thoroughly researched and analyzed before it is established.

There is a rebuttable presumption that where a worker performs services that require a license pursuant to Business and Professions Code, or performs services for a person who is required to obtain such a license, the worker is an employee and not an independent contractor.

     
1. Q. How do I know if I am an employee or an independent contractor?
     
  A. There is no set definition of the term "independent contractor" and as such, one must look to the interpretations of the courts and enforcement agencies to decide if in a particular situation a worker is an employee or independent contractor. In handling a matter where employment status is an issue, that is, employee or independent contractor, DLSE starts with the presumption that the worker is an employee. This is a rebuttable presumption however, and the actual determination of whether a worker is an employee or independent contractor depends upon a number of factors, all of which must be considered, and none of which is controlling by itself. Consequently, it is necessary to closely examine the facts of each service relationship and then apply the law to those facts. For most matters before the Division of Labor Standards Enforcement (DLSE), depending on the remedial nature of the legislation at issue, this means applying the "multi-factor" or the "economic realities" test adopted by the California Supreme Court in the case of S. G. Borello & Sons, Inc. v Dept. of Industrial Relations (1989) 48 Cal.3d 341. In applying the economic realities test, the most significant factor to be considered is whether the person to whom service is rendered (the employer or principal) has control or the right to control the worker both as to the work done and the manner and means in which it is performed. Additional factors that may be considered depending on the issue involved are:
   
1. Whether the person performing services is engaged in an occupation or business distinct from that of the principal;
   
2. Whether or not the work is a part of the regular business of the principal or alleged employer;
   
3. Whether the principal or the worker supplies the instrumentalities, tools, and the place for the person doing the work;
4. The alleged employee’s investment in the equipment or materials required by his or her task or his or her employment of helpers;
   
5. Whether the service rendered requires a special skill;
   
6. 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;
   
7. The alleged employee’s opportunity for profit or loss depending on his or her managerial;
   
8. The length of time for which the services are to be performed;
   
9. The degree of permanence of the working relationship;
   
10. The method of payment, whether by time or by the job; and
   
11. 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.
   
  Even where there is an absence of control over work details, an employer – employee relationship will be found if (1) the principal retains pervasive control over the operation as a whole, (2) the worker’s duties are an integral part of the operation, and (3) the nature of the work makes detailed control unnecessary.

Other points to remember in determining whether a worker is an employee or independent contractor are that the existence of a written agreement purporting to establish an independent contractor relationship is not determinative, and the fact that a worker is issued a 1099 form rather than a W-2 form is also not determinative with respect to independent contractor status.

2. Q. The person I work for tells me that I am an independent contractor and not an employee. He does not make any payroll deductions or withholdings for taxes, social security, etc., when he pays me, and at the end of the year he provides me with an IRS form 1099 rather than a W-2. By paying me in this manner does it mean I am automatically an independent contractor?
     
  A. No. The fact that a person who provides services is paid as an independent contractor, that is, without payroll deductions and with income reported by an IRS form 1099 rather than a W-2, is of no significance whatsoever in determining employment status. Your employer cannot change your status from that of an employee to one of an independent contractor by illegally requiring you to assume a burden that the law imposes directly on the employer, that being, withholding payroll taxes and reporting such withholdings to the taxing authorities.
     
3. Q.

Does it make any difference if I am an employee rather than an independent contractor?

     
  A. Yes, it does make a difference if you are an employee rather than an independent contractor. California’s wage and hour laws (e.g., minimum wage, overtime, meal periods and rest breaks, etc.), and anti-discrimination and retaliation laws protect employees, but not independent contractors. Additionally, employees can go to state agencies such as DLSE to seek enforcement of the law, whereas independent contractors must go to court to settle their disputes or enforce other rights under their contracts.
     
4. Q. When I started my current job my employer had me sign an agreement stating that I am an independent contractor and not an employee. Does this mean I am an independent contractor?
     
    No. The existence of a written agreement purporting to establish an independent contractor relationship is not determinative. The Labor Commissioner and courts will look behind any such agreement in order to examine the facts that characterize the parties’ actual relationship and make their determination as to employment status based upon their analysis of such facts and application of the appropriate law.
     
5. Q. How can it be that the Labor Commissioner determined I was an employee with respect to a wage claim I filed and won, and the Employment Development Department (EDD) determined I was an independent contractor, and denied my claim for unemployment insurance benefits?
     
  A. There is no set definition of the term "independent contractor" for all purposes, and the issue of whether a worker is an employee or independent contractor depends upon the particular area of law to be applied. For example, in a wage claim where employment status is an issue, DLSE will often use the five-prong economic realities test to decide the issue. However, in a separate matter before a different state agency with the same parties and same facts, and employment status again being an issue, that agency may be required to use a different test, for example, the "control test," which may result in a different determination. Thus, it is possible that the same individual will be considered an employee for purposes of one law and an independent contractor under another.
     
6. Q. What can I do if I believe my employer has misclassified me as an independent contractor and as a result am not being paid any overtime?
     
  A. You can either file a wage claim with the Division of Labor Standards Enforcement (the Labor Commissioner's Office), or you can file an action in court to recover the lost overtime premiums. In both situations, it will first be necessary to determine your employment status, that is, employee or independent contractor, before the issue of overtime can be addressed and decided. Additionally, if it is determined that you are an employee and you no longer work for this employer, you can make a claim for the waiting time penalty. Eligibility for this penalty is dependent upon your employment status, as independent contractors are ineligible for the waiting time penalty.
     
7. Q. What is the procedure that is followed after I file a wage claim?
     
  A. After your claim is completed and filed with a local office of the Division of Labor Standards Enforcement (DLSE), it will be assigned to a Deputy Labor Commissioner who will determine, based upon the circumstances of the claim and information presented, how best to proceed. Initial action taken regarding the claim can be referral to a conference or hearing, or dismissal of the claim.

If the decision is to hold a conference, the parties will be notified by mail of the date, time and place of the conference. The purpose of the conference is to determine the validity of the claim, and to see if the matter can be resolved without a hearing. If the claim is not resolved at the conference, the next step usually is to refer the matter to a hearing or dismiss it for lack of evidence.

At the hearing the parties and witnesses testify under oath, and the proceeding is recorded. After the hearing, an Order, Decision, or Award (ODA) of the Labor Commissioner will be served on the parties.

Either party may appeal the ODA to a civil court of competent jurisdiction. The court will set the matter for trial, with each party having the opportunity to present evidence and witnesses. The evidence and testimony presented at the Labor Commissioner’s hearing will not be the basis for the court’s decision. In the case of an appeal by the employer, DLSE may represent an employee who is financially unable to afford counsel in the court proceeding.
     
8. Q. What can I do if I prevail at the hearing and the employer doesn’t pay or appeal the Order, Decision, or Award?
     
  A. When the Order, Decision, or Award (ODA) is in the employee's favor and there is no appeal, and the employer does not pay the ODA, the Division of Labor Standards Enforcement (DLSE) will have the court enter the ODA as a judgment against the employer. This judgment has the same force and effect as any other money judgment entered by the court. Consequently, you may either try to collect the judgment yourself or you can assign it to DLSE.
     
9. Q. What can I do if my employer retaliates against me because I thought I was misclassified as an independent contractor and objected to not being paid overtime?
     
  A. If you are an employee and your employer discriminates or retaliates against you in any manner whatsoever, for example, he discharges you because you question him about your employment status, or about not being paid overtime, or because you file a claim or threaten to file a claim with the Labor Commissioner, you can file a discrimination/retaliation complaint with the Labor Commissioner’s Office. In the alternative, you can file an action in court against your employer. If, on the other hand it is determined that you are in fact an independent contractor, DLSE cannot assist you as it does not have jurisdiction over independent contractors, and you would have to go to court to enforce your rights.
     

 

 

 

All contents ©2017 MTCLaw.com. All rights reserved.