Are you thinking that the great graphic designer you just found will be an Independent Contractor with your company? Think again.
We’ve all heard of them, companies that have few, or no employees at all – they only use independent contractors. The thinking goes: 1) it’s cheaper by far, no employment taxes, and 2) no employer liability – you can’t get sued for harassment, discrimination etc.
Sounds good – so what’s the problem? It’s expensive to get it wrong. FedEx misclassified their drivers as independent contractors, and ended up settling a California class action lawsuit for $228 million.
In the past, two federal agencies helped govern this issue – the Department of Labor, and the Internal Revenue Service. The DOL is committed to making sure that employers do not displace employees (denying employment benefits and protections); and the IRS, simply put, wants employment taxes. The oversight (and potential fines) from these two agencies make it critical that you remember two things:
And, one other new item – the California Supreme Court has gotten in on the action. The Supremes have decided that, unlike both the IRS and DOL tests, an individual must meet all of California’s guidelines to classify as an independent contractor (the IRS and DOL tests require some, or most – but not all).
The Supremes adopted what is called the ABC Test to distinguish between employees and independent contractors:
A. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work, and in fact.
This means, all independent contractors should sign an Independent Contractor Agreement, drafted by your counsel. The agreement should explicitly state that the worker is free from the control and direction of you or your company. And finally, you have to ensure that is what actually happens. No matter if the agreement is correctly stated; if your actions are contrary, you will have exposure.
B. The worker performs work that is outside the usual course of the hiring entity’s business
This factor is the most problematic. A worker might meet both the A and C factors, but work on something that is within your business’s core product or service; this will mean they would not meet the B factor.
Example X: You are an accounting firm, and during tax time you hire two accountants to help out – they will not clear factor B, because the work they are doing is part of the usual course of an accounting firm’s business.
Example Y: You are a bakery that occasionally hires cake decorators. The decorators would not clear the B factor, because they are providing a service that is part of your business.
Example Z: You engage individuals to perform sales cold calls for your company. They would not clear the B factor, because sales is a primary part of all businesses.
C. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.
The simplest way to ensure that the worker meets factor C, is to make sure they are incorporated to perform the same nature as the work performed – with all the attendant insurances, licenses, EIN etc., required of businesses in their state of incorporation.
The choice to incorporate must be the worker’s and cannot in any way come from the hiring entity.
On the face of it, this decision seems to significantly impact gig economy companies. But, it will also have a lasting impact on all California businesses. A few other items of note:
FedEx misclassified their drivers as independent contractors, and ended up settling a California class action lawsuit for $228 million.
The preceding is provided for general informational purposes only, and not intended to constitute legal advice.