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The Art of Correctly Classifying Workers

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On a clear and beautiful afternoon, Mom, the owner of Mom's Delicious Pies (the names have been changed to protect the innocent) decided to hire her next-door neighbor, Susie, to do some marketing, outside sales, and advertising for the pie shop.

Susie was a stay-at-home mom that worked about 10-12 hours per week from home, and was just looking to make some extra spending cash. Mom's Delicious Pies' human resource director, Dad, told Susie that the company would cut her a check every week for the hours she worked, and would "1099" her at the end of the year. That way Susie could take care of the appropriate state and federal taxes on her own at year-end, and Dad could avoid the paperwork and hassle of designating her as an "employee." Dad thought Susie was an Aindependent contractor. Unfortunately, Dad didn't consult with his friendly, neighborhood employment attorney before making this decision.

The California Employment Development Department (EDD), without any prompting or complaint, audited Mom's Delicious Pies and determined that Susie had been misclassified as an independent contractor. The EDD determined that Susie should have been an employee. Dad was fired. Mom's paid a hefty fine and faced a nightmare with the IRS and the California Franchise Tax Board.

So where did Mom's go wrong? The Internal Revenue Service uses a 20-point test to determine if a worker is an "independent contractor." As such, when determining a worker's classification, business owners will be asked the following questions to determine whether the worker(s) in question are employees or independent contractors:

  • Whether the employer can fire the worker "at will";
  • Whether the worker is engaged in a distinct occupation or business;
  • Whether the work is usually done under the direction of the employer or by the worker without supervision;
  • Whether the worker requires any training, including attending meetings and working closely with experienced employees;
  • The level of skill required in a particular occupation;
  • Whether the worker can set his/her own hours of work;
  • Whether the level of effort requires a full-time devotion;
  • Whether the work requires a specific sequence of activities;
  • Whether the worker supplies his own instrumentalities, tools or work space;
  • The length of time for which the services are to be performed;
  • The method of payment, either by the time or a flat-rate paid per job;
  • Whether the work is integrated as a part of the "regular business" conducted by the employer;
  • Whether the parties believe they were creating an employer-employee relationship;
  • Whether the worker received reimbursements for business or travel-related expenses;
  • Whether the classification as an independent contractor is bona fide, and not a "subterfuge" to allow the employer to avoid designating the worker as an employee;
  • Whether the worker holds himself out as having his own business and/or business license;
  • Whether the worker is required to render services personally;
  • Whether the worker has employees of his/her own;
  • The worker's opportunity for profit or loss depending on his/her managerial skills; and,
  • Whether the services provided is "an integral part of the employer's business."

When determining whether a worker is an independent contractor or an employee, the EDD (or the court, if a lawsuit is filed) will look at the totality of the answers to the questions above. There is no single question that is determinative, one way or another, on the issue of classification. However, all of the categories above basically boil down to how much control the business exercises over the work being performed. The higher the degree of control, the more likely the worker will be classified as an employee, rather than an independent contractor! Unfortunately, even though there is an objective measurement applied, many times the decision on classification becomes quite subjective depending on who is evaluating the factors. As such, while an employer may believe they are on the right side of the balancing test, ultimately it is an auditor or a jury who will determine whether the scales tip in favor or against the business.

While employee classification is clearly not an exact science, an employer can take steps to minimize its potential liability for misclassifying its workers by consulting an employment attorney. A brief review of the worker's job duties, the employer's oversight abilities and the general type of business conducted by the employer will assist an attorney in making an informed decision, and will allow the employer to recognize the potentially expensive risks associated with misclassifying workers as independent contractors, rather than as employees.

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