Every day, we read about how the gig economy continues to grow, that more and more companies across all industries engage new workers every day as independent contractors. Before engaging a worker as an independent contractor, companies should consider whether their utilization of independent contractors is in compliance with all relevant laws.
It is important to note that different jurisdictions apply different tests to determine whether a worker should be classified as an independent contractor versus an employee. The tests are generally similar. However, they can have major differences.
How would a company know what test to apply? It depends on facts relating to a company’s engagement of a worker. Upon the initial engagement, a company should consider all the potential classification tests, as the company would need to make sure its classification of a worker will pass any test which may be applied. However, if a company is audited for worker classification, or a claim is brought against a company, it will have to apply the specific rules followed by the auditing agency or other legal tribunal. For example, the IRS would apply the IRS 20 factors if it conducts an IRS audit.
There are many different tests could be applied. Along with the IRS 20 factors (applied in IRS audits), There are also states’ common law tests (applied, for example, in unemployment cases and workers compensation cases); the Economic Realties test or “the 6 factors test” (applied, for example, in benefits cases); and the ABC test, (applied, for example, in wage order cases).
Companies should note that there are also industry specific regulations which cover worker classification. A short list of examples includes specific regulations that address: the real estate industry; newspaper distributors; securities dealers; the construction industry; the manufacturing industry; salespeople; the taxicab industry; the restaurant industry; barbers; and telemarketers. These regulations must also be addressed and not overlooked prior to engagement.
Companies that bring on workers as independent contractors without properly defining the project or confirming that the worker utilized is in fact an independent contractor, will result in significant risk of exposure to audits and legal claims.
The IRS and state auditing agencies (e.g. California’s EDD) audit companies who do not comply with payroll laws as a result of independent contractor misclassification.
Reclassification can result in an employer paying both the employer and employee share of payroll taxes for up to three (3) years. Additional assessments for interest can also be applied. If the misclassification is deemed intentional, a company could be fined up to $25,000 per violation in some cases (e.g. per the California labor code).
Additionally, legal claims brought by individuals against companies for worker misclassification involve workers who demand employee protections relating to rights that do not apply to independent contractors.
Workers reclassified as employees are entitled to appropriate compensation relating to wage and hour laws (e.g. overtime, meal and rest breaks, compliance with minimum wage regulations). Reclassified employees also bring claims relating to wrongful discharge, workers’ compensation and rights to employee benefits.
The legal exposure resulting to reclassification may include fines and penalties (including the possibility of criminal penalties) beyond plaintiffs’ monetary awards in court. Plaintiff’s attorneys’ fees may also be included in the settlement. Liability may extend to the company’s officers.
Before a company joins in on the gig economy, proper consideration should be given to the nature of the engagement contemplated and whether the planned relationship will comply with all laws and regulations governing the use of independent contractors. There are many legal considerations that should be taken into account prior to utilizing a worker as an independent contractor and costs relating to a misclassification should never be ignored.
Geoff Mohun is General Counsel and the Chief Compliance Officer for iWorkGlobal. He has a Juris Doctorate from John F. Kennedy School of Law and is a graduate of California State University, Chico. He was admitted to the State Bar of California in 1997. Connect with Geoff on LinkedIn.