Employee or Independent Contractor: How the Dynamex Decision Affects Your Business

November 2018

Employee or Independent Contractor:

How the Dynamex Decision Affects Your Business

As an employer, you must decide whether to classify your workers as employees or independent contractors. It is critical to understand the difference between the two classifications, as well as their legal implications.

Under the law, an “independent contractor” is defined as a person working free from the control and direction of the employer. He performs work outside of the hirer’s company and routinely engages in an independent trade, occupation, or business. An “employee” is defined as a worker that performs under the control and direction of the employer for the purposes of the hirer’s business.

In California, the Employment Development Department (EDD) and Division of Labor Standards Enforcement (DLSE) typically handle the classification of workers as independent contractors or employees. The California Supreme Court recently revised its test for classifying workers as either independent contractors or employees in wage-related claims (see Dynamex case below).

Formerly, there were many benefits to hiring independent contractors. However, the new ruling makes it more difficult to classify your workers as independent contractors rather than employees. As an employer, it is important to understand this new standard in the employment law context.

Below is an overview of the changes and factors to consider when determining whether to classify your workers as independent contractors or employees.

A New Legal Standard to Classify Independent Contractors

For decades, California used the test set forth in S.G. Borello & Sons, Inc. v. Dept. of Industrial Relations, which required the court to look at 11 different factors to determine whether a worker was an independent contractor. If a worker fulfilled several of the conditions, it was permissible to classify them as independent contractors rather than employees. For non-wage-related claims, Borello may still apply but in most cases the standard used in Dynamex will apply.

Recently, in April 2018, the court rejected the 11-factor test in favor of a new standard defined in Dynamex Operations W., Inc. v. Super. Ct. Under the new test, an employer must prove all three of the following factors in order to classify their worker as an independent contractor:

  • (A) The worker is free from the direction and control of the employer in connection with performing the work, in reality and under the terms of the contract;
  • (B) The worker routinely performs work outside of the usual course of the employer’s business; and
  • (C) The worker is customarily engaged in an independent trade, occupation, or business that is the same work as the work being done for the employer.

In most cases, the Borello standard is no longer available, which allowed the employer to classify a worker as an independent contractor when only some conditions were fulfilled. Now, employers must classify a worker as an independent contractor by fulfilling all three factors in Dynamex. It is important to note that this can get tricky for employers who routinely hire in-house workers who also perform work elsewhere.

For example, a worker hired to perform oil changes as a mechanic is likely to be classified as an employee because their duties are regularly performed by the employer. However, an electrician hired to fix the electrical problems in a hardware store or a painter hired to repaint the front of a shoe store is likely to be classified as an independent contractor because the work being performed is not part of the usual course of the company’s business.

The California  Division of Labor Standards Enforcement (DLSE) will use the new test when classifying workers as independent contractors. Other governmental agencies, such as the Contractors State Licensing Board and Franchise Tax Board, may consider other factors when classifying workers for the purposes of licensing or tax reasons.

Implications of the Dynamex Ruling

Economists estimate 12.5 million workers in the United States, or 8.4% of the national workforce, were independent contractors in 2016. By narrowing the test to three factors, the California court has made it more difficult to classify a worker as an independent contractor.

Therefore, as an employer, it is imperative to understand how and why an independent worker is classified differently than an employee. You should be familiar with the distinction and ensure that your workers are classified correctly. Independent contractor laws affect wages, taxes, insurance, workers’ compensation, and more. Make sure you consult with an expert when classifying your workers.

Consequences of Misclassification

According to the California Labor Commission, the misclassification of workers as independent contractors instead of as employees costs the state $7 billion in lost payroll taxes every year. As a result, the state is taking an even closer look at companies that classify their workers as independent contractors.

They’re penalizing those that misclassify employees, sometimes with devastating results for the employer’s company. Under California Labor Code Section 226.8, an employer that misclassifies an employee may be subject to fines between $5,000 to $15,000 for each violation. If the state finds the employer engaged in willful misclassification that was done knowingly and voluntarily, the fine increases to $10,000 to $25,000 for each misclassification offense.

On the federal level, the IRS can impose penalties of 1.5% of the wages, plus 40% of the FICA taxes. For intentional misconduct, the IRS can impose even more penalties including fines up to 20% of all wages paid, plus 100% of the FICA taxes.

In addition to governmental fines and penalties, the misclassified worker can also seek restitution from the company. The employee can seek up to three years’ worth of unpaid wages, including overtime and loss of meal or rest breaks, unreimbursed business expenses, and additional money for labor and employment law violations such as failure to cover workers’ compensation for the employee.

How to Protect Yourself After Misclassifying Workers as Independent Contractors

The best way to protect yourself and your company from fines and penalties for misclassification of employees is to consult with an experienced employment law attorney before hiring workers. However, if you have already hired employees and misclassified them as independent contractors, there are steps you can take to mitigate the damage.

First, keep detailed policies and records of all workers who are identified as independent contractors, and why. Keep any relevant documents that prove workers meet the standard of independent contractors to avoid any other misclassification.

If the government does step in after an employee is misclassified, they will most likely perform an audit of the company to ensure no other misclassification of employees has occurred. In this case, the best thing you can do to protect yourself is to hire a lawyer.

An employment law attorney can serve as a shield between you and the government investigating your company. They can help negotiate any proposed fines and make the legal arguments as to why your workers are classified as independent contractors. If necessary, a lawyer can appeal a decision on a misclassified employee and fight to protect you and your business in court.

An Employment Law Lawyer Can Help

Misclassification of an employee in California is a very serious matter that can have a devastating impact on your business. As an employer, if you have concerns about misclassifying employees as independent contractors, contact an experienced employment law attorney today.

If you would like any additional information or have any other questions about employment law, feel free to contact us.

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