One of the most heavily contested issues among business owners and the Internal Revenue Service/Employment Development Department is the classification of individuals in your employment as “independent contractors” or “employees”. The former does not require any tax withholdings to be made by the employer and, therefore, the reclassification of workers as employees may result in back payroll taxes being assessed as well as substantial interest and penalties for failing to pay employment taxes. If the EDD decides to reclassify multiple workers, this could result in significant liability owed to the State of California.  These independent contractor reclassification audits can be costly for a business.

The IRS uses a twenty factor test for classifying workers, which the Employment Development Department has adopted as well in making its determinations. Generally these factors fall into three categories:

1. Behavior Control;
2. Financial Control; and
3. The Type of Relationship between the employer and the worker.

Independent Contractor Reclassification Audits

The California Supreme Court recently issued an ABC test for determining whether a worker is an employee or an independent contractor in a wage and overtime case.  It is not clear whether the EDD will apply the ABC test moving forward.  The ABC test states a worker is an independent contractor only if each of the following conditions are met:

1. The worker is free from control and direction of the hirer;
2. The worker performs work outside the usual course of the hiring entity’s business; and
3. The worker is customarily engaged in an independently established trade, occupation, or business as the same nature as that involved in the work performed.

Certain provisions of state and federal law automatically classify certain workers as employees or independent contractors.  For example, anybody who does construction work for a licensed contractor in California is automatically an employee under California law unless the worker has his or her own contractor’s license.  It does not matter what type of working relationship the construction worker has with the licensed contractor.

There is no set formula or combination of factors that will automatically classify a worker as an employee or an independent contractor. The law is extremely nuanced and the federal and state governments have been increasingly aggressive in classifying independent contractors as employees. Your intent to hire workers as independent contractors is simply not enough. Therefore, it is important to have an experienced tax attorney represent you in independent contractor disputes before the government. Reclassification can result in thousands of dollars in increased tax liability. Better still, our law firm can help you draft independent contractor agreements as a preventative measure to curtail liability before it arises. Although no agreement is “airtight,” a free consultation can help better define your workers’ role according the guidelines and will help minimize exposure should the tax authorities pursue action against you.

If you have any questions or if we can further assist you, please contact our office.  We have locations throughout Southern California including El Cajon, Irvine, and San Diego.

For more information, please see:

• IRS Payroll Tax Main Page
• The IRS Trust Fund Recovery Penalty
• Independent Contractor Reclassification Audits