Classifying Independent Contractors and Employees and EDD Enforcement Audits

When confronted with an enforcement audit by the California Employment Development Department (“EDD”) “Joint Strike Task Force,” how prepared is your business? One area of increasing focus among courts and administrative agencies charged with enforcing the California Labor Code, the California Business and Professions Code, and the Unemployment Insurance Code is the misclassification of workers as independent contractors rather than as employees. This issue generally arises when the EDD conducts a payroll tax audit of your business. Such audits generally cover the past three years, although they may extend further into the past in cases where no returns have been filed. Businesses commonly fail to file employment tax returns when they believe they only hired independent contractors and thus had no duty to file tax returns or comply with other state labor laws and regulations involving employees. Audits are often triggered when an individual classified as an independent contractor files a workers' compensation claim or applies for unemployment insurance benefits.

Misclassifying employees as independent contractors, however, could cost your business substantially. There are benefits to using independent contractors in proper situations, such as not having to pay overtime, provide benefits, remit payroll taxes, or provide workers' compensation insurance. Although using independent contractors can provide benefit to the bottom line, companies must make sure that workers classified as independent contractors are truly independent contractors and not employees. Misclassifying workers can result in substantial penalties and assessments, including stop work orders while having to continue paying employee wages, payment for past overtime and meal periods, tort liability from injured workers that would have been covered under workers' compensation insurance, exposure to suits for unfair business practices, past tax liability and penalties, and possible criminal sanctions.

A recent case from the California Courts of Appeal highlights a changing trend in how enforcement agencies and California courts analyze whether a worker is an independent contractor or employee. The traditional test considered factors such as the right of the business to control the day-to-day activities of the worker, the degree of skill required to achieve a desired result, whether the worker or the business provided tools and equipment for the job in question, the length of time for which the worker was to perform services, the method of payment, and the degree to which the worker could independently determine how best to achieve the desired result of the employer. While those factors are still important, especially the right of control, the modern trend focuses on the critical question of whether the work performed is an integral part of the business. In simpler terms, does the worker provide services that are at the core of the business? The case illustrating this modern trend involved drivers working for a courier service. The Labor Commissioner determined that making deliveries was at the core of the courier service business and therefore delivery-persons were not independent contractors but rather employees. The inquiry centered on the relationship between the work performed and the employer's core business. This result was affirmed by California courts.

If one or more of your independent contractors provide services that relate to the core of your business, carefully consider whether reclassification is necessary or required in order to avoid the risks and possible assessments of an EDD audit. For more information, consult an attorney in our Employment and Benefits Group.

 

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Please note that the information contained in this newsletter is not intended to provide specific legal advice. You should consult with an attorney and not rely on any information contained herein regarding your specific situation.