Whether an employer classifies a worker as a contractor or a W-2 employee raises important wage and tax withholding issues. Nonexempt W-2 employees are entitled to overtime and both exempt and nonexempt employees are entitled to minimum wage, meal and rest periods, and reimbursement of ordinary business expenses. Employers have to pay half of W-2 employees' social security and medicare taxes (the "payroll tax"), while contractors pay 100% of these taxes.
Employers often improperly classify employees as independent contractors to avoid paying payroll taxes, the minimum wage or overtime, and to avoid other wage and hour rules, meal and rest break requirements, and business expense reimbursements. Additionally, employers can evade workers’ compensation insurance by classifying workers as independent contractors.
Misclassifying an employee as an independent contractor to save a few dollars is a pretty stupid thing to do. It means that if the worker suffers an on-the-job injury, he can sue the employer and isn't subject to the damages limitations of the worker compensation laws - the worker can get damages for pain and suffering, which may be remarkably high. And worker compensation insurance is cheap compared to liability for on-the-job injuries.
Most California workers compensation policies require you to present a valid certificate of workers compensation coverage for each contract worker. That is to say, most workers compensation insurance contracts in California require to the employer prove that any 1099 contractors had their own valid workers compensation policies in effect at the time that you employed them. After all, if they have their own contracting business, we can expect that they will have insurance.
Additionally, the State of California seriously dislikes willful misclassification. The civil money penalty for a single misclassification is between $5,000 and $15,000, but not less than $5,000. The employer's share of taxes and insurance for an employee making $31,200 a year is less than $3,000 a year and that includes the peace of mind that comes with knowing you haven't cut corners.
California law even imposes an embarrassing requirement that an employer found to have willfully misclassified a worker must place a prominent notice on the company's website for one year informing visitors of the ignominious offense.
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 its Division of Labor Standards Enforcement (DLSE), which is concerned with whether wage, hour and workers’ compensation insurance laws apply. Other agencies like the Franchise Tax Board (FTB), Division of Workers’ Compensation (DWC), and the Contractors State Licensing Board (CSLB) also regulate 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 employer treats a worker as an independent contractor who is later found to be an employee, employers should have an attorney carefully review each working relationship before classifying a worker as an independent contractor.
A company must prove it is an "employer" to secure an H-1B petition for an employee. As in the employment law context, the employer's designation of a worker as contractor, or employee is less important than the facts of the relationship which are defined by control. US Citizenship and Immigration Services issued a memo on January 8, 2010 noting that it would not approve H-1B petitions unless filed by the "employer" as defined by case law addressing the employee-independent contractor question. Determining Employer-Employee Relationship for Adjudication of H-1B Petitions, Including Third-Party Site Placements, Donald Neufeld, Jan 08, 2010, HQ 70/6.2.8 AD 10-24.
The Neufeld memo notes that INA 101(a)(15)(H)(i)(b) and 8 CFR 214.2(h)(2)(i)(A) both mention "employer" or "United States employer" that has an "employer-employee relationship" as the petitioner. This memo has caused headaches for staffing and placement firms that do indeed pay payroll taxes, withhold income taxes, pay workers' compensation insurance and otherwise serve as employers except in some cases with regard to their control over the employee's work. The Neufeld memo looks to two important US Supreme Court Cases that define the factors to consider in deciding whether a common law employer-employee relationship exist. Those two cases are:
The United States Supreme Court noted in Darden:
We consider the hiring party's right to control the manner and means by which the product is accomplished. Among the other factors relevant to this inquiry are the skill required; the source of the instrumentalities and tools; the location of the work; the duration of the relationship between the parties; whether the hiring party has the right to assign additional projects to the hired party, the extent of the hired party's discretion over when and how long to work; the method of payment; the hired party's role in hiring and paying assistants; whether the work is part of the regular business of the hiring party; whether the hiring party is in business; the provision of employee benefits; and the tax treatment of the hired party. Darden at 323-24.
The January 8, 2010 Neufeld memo more or less inquires as the same factors in Darden. USCIS now requires that the H-1B petitioner establish that it has the right to control over when, where and how the beneficiary performs the job and will consider the following factors (with no one factor being decisive) to determine employer control:
The Neufeld memo then uses examples to classify employment into four types of acceptable employment:
And three types of unacceptable employment:
The Neufeld memo requires a petitioning employer to supply the following documents to satisfy the employer-employee relationship:
Just because someone else is paying a worker's payroll taxes and workers' compensation insurance doesn't mean that you aren't their employer. Many employers learn through experience that using a staffing or placement service can result in later reassessments of the employer-employee relationship. A reassessment may reclassify staffed workers as your employees. An after-the-fact legal determination that a worker is an employee may result in signficant financial liabliity.
If you would like more information about whether a worker should be classified as an employee, or a contractor, please contact us.