A Modern Look at Contractors v. Employees

*Employment and Privacy Counsel
Workplace Investigator (Spanish and English)
www.dianamaierlaw.com
A Modern Look at Independent Contractors v.
Employees:
Presented by:
Law Offices of Diana Maier*
&
DLSE Hearing Officer Carlos Torres

This information is provided for general
information only. None of the information
provided herein should be construed as
providing legal advice or forming an
attorney client relationship. Applicability of
the legal principles discussed may differ in
individual situations. You should not act
upon the information presented herein
without consulting an attorney of your
choice about your particular situation.

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I. Frequent Terms and Their Meanings
Person Paying for the Services: Principal versus Employer
Person Providing the Services: Worker/Contractor/Consultant versus Employee

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II. Central Questions
•  What are some ethical considerations to keep in mind as we review the material?
•  Why are we here?
•  Factors in classification
•  Advantages and disadvantages of each classification
•  How does the government know/find out?
•  What are the penalties if you get it wrong?
•  What do you do to protect yourself?

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Rule 2.1 – Advisor
•  “In representing a client, a lawyer shall exercise independent professional judgment and render
candid advice….A lawyer may refer not only to law but to other considerations such as moral,
economic, social and political factors, that may be relevant to the client’s situation.”
•  Purely technical legal advice can sometimes be inadequate to the client, and it is proper for the
lawyer to refer to ethical and moral considerations in giving advice.
ETHICAL CONSIDERATIONS
Model Rules of Professional Conduct

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•  2009 GAO Report: $7 billion in lost payroll tax revenue over the next 10 years for treasury
because of misclassification
•  For every 1% of workers misclassified = states lose ~ $198 million each year in unemployment
insurance funds
WHY ARE WE HERE?
The Federal Government Is Cracking Down

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•  New federal initiatives to increase enforcement against employers who are misclassifying:
•  In September 2011, the IRS and DOL combined forces by executing a Memorandum of
Understanding (“MOU”) to conduct joint investigations and share information
•  DOL pursuing similar joint agreements with the states. As of October 2015, the DOL has
executed MOUs with 26 states including CA
WHY ARE WE HERE?
The Federal Government Is Cracking Down

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•  Beginning January 1, 2012, significant increase in the penalties that can be assessed against
employers who “willfully” misclassify individuals (adds §§226.8 & 2753 to CA Labor Code)
•  Authorizes the Labor Commissioner, or a court, to assess specified civil penalties
•  Requires employers who violate to put on website that the employer “has committed a serious
violation of law by engaging in willful misclassification of employees”
•  Carries exposure for a civil penalty of between $5,000 and $15,000 for each violation, but if a
“pattern or practice of violations,” the civil penalty is increased to between $10,000 and
$25,000 per violation!
WHY ARE WE HERE?
The State Government Is Cracking Down

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•  Any person rendering service for another, other than an independent contractor, is presumed
to be an employee
(Lab C §3357)
•  So if worker challenges a classification, then burden shifts to employer to prove wrong
HOW DO YOU KNOW WHO IS WHICH?
Presumption of Employment

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III. Central Questions
DLSE STANDARD – Division of Labor Standards Enforcement
•  Generally the DLSE applies the “multi-factor” or the “economic realities” test adopted by the
California Supreme Court in the case of S. G. Borello & Sons, Inc. v. Dept. of Industrial Relations
(1989) 48 Cal.3d 341.
•  Most Significant Factor: whether the person to whom service is rendered has control or the
right to control
Formal Factors: Agency Examples

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•  Are the services performed in an occupation or business distinct from that of the principal?
•  Is the work part of the regular business of the principal or alleged employer?
•  Who supplies the instrumentalities, tools, and the place?
•  What is the worker’s investment in the equipment or materials required by his/her task or his/
her employment of helpers?
•  Does the service rendered require a special skill?
Additional Factors in Borello Case

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•  To what degree is the work usually done under the direction of the principal or by a specialist
without supervision?
•  What is the worker’s opportunity for profit or loss depending on his or her managerial skill?
•  What is the length of time for which the services are to be performed?
•  What is the degree of permanence of the working relationship?
•  Is the method of payment by time or by the job?
Additional Factors in Borello Case (Continued)

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•  Whether or not the parties believe it is an employer-employee relationship (including existence
of a written agreement) may have some bearing on the question, but it IS NOT determinative
since this is a question of law based on objective tests. (Borello, Id. at 349)
•  Issuing a 1099 form rather than a W-2 form IS NOT determinative with respect to
independent contractor status. (Toyota Motor Sales v. Superior Court (1990) 220 Cal.App.3d 864,
877)
What Else Case Law Says

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•  Even where there is an absence of control over work details, an employer-employee
relationship will be found if:
1.  The principal retains pervasive control over the operation as a whole
2.  The worker’s duties are an integral part of the operation (Uber case - sharing economy)
3.  The nature of the work makes detailed control unnecessary
•  (Yellow Cab Cooperative v. Workers Compensation Appeals Board (1991) 226 Cal.App.3d 1288)
What Else Case Law Says (Continued)

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•  Save Money
•  No mandated contributions (State and Federal unemployment tax, Social Security, Medicare,
disability)
•  No discretionary fringe benefits (medical insurance, vacation time, etc.) or mandatory
benefits (SF sick leave)
•  No mandated workers’ comp coverage
•  Administrative savings
•  Minimizes Liability - not responsible for injuries of workers of contractors
ADVANTAGES OF PAYING YOUR PROVIDER LIKE A CONTRACTOR

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•  Requires less record keeping/reporting
•  Allows for highly specialized personnel
•  Usually means less need to hire counsel to abide by employment laws
•  No pregnancy leave, required leaves, wrongful termination actions, etc.
•  Greater flexibility to enter into new areas of business
ADVANTAGES OF PAYING YOUR PROVIDER LIKE A CONTRACTOR

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•  Presumption of Employment: any person rendering service for another, other than as an
independent contractor, is an employee. Labor Code § 3357
•  Steep penalties if you get it wrong
•  By definition, you aren’t exercising control over a contractor, so it requires a hands-off
approach in order to stick
•  Means combating the current political tide!!!
DISADVANTAGES/RISKS OF PAYING YOUR PROVIDER LIKE A
CONTRACTOR

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•  Loss of copyright/trade secret ownership
•  JustMed, Inc. v. Byce (9th Cir. 2010)
•  Restrictions on right to “fire” (assuming an IC-client agreement)
•  Loss of continuity in relationship
•  Must monitor legality of relationship
DISADVANTAGES OF PAYING YOUR PROVIDER LIKE A CONTRACTOR

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•  AUDITS: The CA Employment Development Department conducts audits of businesses
claiming independent contractor-principal relationships. These audits usually arise when an
individual who has been treated as an independent contractor files for unemployment benefits.
An “obstructed claim.” About 90% come up this way
•  COMPLAINTS: Wage and hour complaints may also lead to audits by the U.S. Dept. of
Labor, or by the CA Division of Labor Standards Enforcement
•  TIPS: Labor commissioners also get tips or discover it in the course of investigating someone
else
HOW DOES THE GOVERNMENT KNOW WHO YOU’VE CLASSIFIED AS WHICH?
(And Decide to Intervene?)

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•  SHARED INFORMATION: Joint task force between EDD and DLSE
•  IRS: The IRS initiates audits of businesses claiming independent contractor – principal
relationships
•  SELF-REPORTING: State law requires all employers to report all new hires/should report
new 1099s as well
•  THE INDUSTRY AT HAND IS TARGETED
HOW DOES THE GOVERNMENT KNOW WHO YOU’VE CLASSIFIED AS WHICH?
(And Decide to Intervene?)

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•  Employer who fails to withhold or make employment tax payments for the worker is liable for
such payments, including penalties and interest. IRC §3402(g)
•  Federal: If an employer fails to withhold federal taxes, the employer will be penalized at a
substantially higher rate if the misclassification is deemed to be intentional
•  California: Failure to withhold or pay California taxes will result in the same penalty whether or
not the employee was intentionally or unintentionally misclassified
WHAT ARE THE PENALTIES FOR MISCLASSIFYING?
Tax Penalties

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•  Unemployment insurance contributions
•  State disability insurance
•  Interest, penalties of up to 10% for estimated employer and worker contributions
•  Possible criminal penalties
EDD Sanctions

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•  An action by the injured employee (Lab C§3706-3708)
•  A stop order prohibiting the employer from using employee labor until workers’ comp
payments are made (Lab C §3710.1)
•  Civil penalties of up to $10,000 per employee (Lab C §3702.9, 3722)
•  A lien on employer property (Lab C §3722)
•  Criminal misdemeanor penalties (Lab C §3700.5, 3710.2, 3751)
CA Workers’ Compensation/DLSE Penalties

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•  Minimum wage and overtime amounts the employer should have paid (Lab C §1197)
•  Interest on unpaid minimum wage and overtime amounts (Lab C §98.1, 1193.6)
•  Penalties for failure to pay minimum wage and overtime (Lab C §1197.1(a), 1194.2, 204, 210)
•  Attorney fees and costs (Lab C §1193)
•  Labor Code section §226: failure to give wage statement
Liability for Minimum Wage and Overtime

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•  Build a vendor file that says they are an independent contractor (file business cards, copies of
invoices, advertisements, proof they have employees, and other indicia of business)
•  Don’t tell contractor how long to stay/what to do
•  Contractor should tell you the price, not the other way
•  Pay by job, not by the hour
•  Find someone advertising their services as opposed to seeking them out
IF YOU DECIDE TO PAY YOUR WORKER AS A CONTRACTOR, WHAT’S
HELPFUL?

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•  Secure written agreement:
•  Indicating “lack of control,” e.g. payment on project basis
•  Have a clear term (a one-year agreement and renew)
•  Have them bring their own tools/supplies
•  File a 1099 and DE 546 form
IF YOU DECIDE TO PAY YOUR WORKER AS A CONTRACTOR, WHAT’S
HELPFUL?

III. Sharing Economy
WHAT IS THE SHARING ECONOMY?
•  Based on the idea that information technology can provide people with information that enables
distribution, sharing, and reuse of excess capacity in goods and services
•  Companies have started to deliver on-demand services, such as driving, dry cleaning, and
shipping
•  Businesses tend to have independent, flexible structures
•  Most companies classify their workers as independent contractors rather than employees
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WORKER CLASSIFICATION – INDEPENDENT CONTRACTOR
•  Companies tend to choose contractor status rather than employee:
•  Not necessarily a set schedule, a desk to sit behind, or a boss to answer to
•  Opportunity to take or refuse engagements as workers desire
•  Limited or nonexistent control over workers
•  However, there have been issues with this lately
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CLASSIFICATION LAWSUITS
•  Many on-demand sharing economy companies have been sued for misclassifying their workers
as independent contractors
•  e.g. Lyft, Uber, Washio, Homejoy, Shyp, Postmates, Instacart, Handy
•  Most of these companies are completely dependent on their workers, which strongly indicates
employee status
•  U.S. DOL released a memo in July 2015 stating that “most workers are employees under the
FLSA’s broad definitions”
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CLASSIFICATION LAWSUITS
•  Is this a moral issue? Here’s what the class action attorney in the Uber case said:
"I don’t believe this industry needs to be built on a system whereby the workers don’t… receive
any of the protections that we [as a] society [have decided] that workers need to receive," she
said. "I just don’t know how Uber can argue with a straight face that as a $40 billion dollar
company it can’t afford to insure its drivers, pay minimum wage or pay overtime, or be
reimbursed for their expenses. This is not going to put Uber out of business."
•  http://www.businessinsider.com/shannon-liss-riordan-the-lawyer-behind-ubers-lawsuit-2015-5
30

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IV. Ethical Issues Revisited
Rule 2.1 – Advisor
•  “In representing a client, a lawyer shall exercise independent professional judgment and render
candid advice….A lawyer may refer not only to law but to other considerations such as moral,
economic, social and political factors, that may be relevant to the client’s situation.”
•  Purely technical legal advice can sometimes be inadequate to the client, and it is proper for the
lawyer to refer to ethical and moral considerations in giving advice.
Model Rules of Professional Conduct

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IV. Ethical Issues Revisited
•  Given that this is a subjective standard, what ethical considerations exist for attorneys who need
to advise others about this? Complicated by the fact that 1099 is less expensive.
•  Do you pick the argument most conducive to the business and just go with that?
•  How do the political/social factors come into play?
•  Are there law and policy objectives lawyers have a duty to protect?
•  If there are, has current law accomplished those, or have we gone too far?

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V. Cases: Practicing the Material
Case #1: Client Engaging New Service Providers
A client tells you that she is engaging new service providers and explains that she is low on funds
and does not want to classify them as employees. However, they will work for her full time, in an
administrative capacity, under her full control, and have no other employer.
•  What’s your ethical duty to advise her according to rule 2.1 of the model rules of professional
conduct? What if she assures that her service providers want to be contractors?

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Case #2: Corporate Employer
A small company decides that it doesn’t need to classify two service providers as workers and
issues a 1099 to these folks for three years in the amount of $60K a year or $360K total.
If both the EDD and IRS audit and reclassify the providers as employees, the assessment (not
including interest or penalties) will be as follows:
•  Unintentional Misclassification and 1099 filed: $79K
•  Unintentional Misclassification and no 1099 filed: $86K
•  Intentional Misclassification: $146K-174K

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Case #3: Domestic Employer
•  Family hires a nanny and does not treat her as an employee. In fact, pays her “under the table.”
•  Family is caught, and pays government all the taxes they owed, taxes the nanny owed, penalties,
and interest. In total, family pays 15-20% more than they would have paid if they had treated
her as an employee and paid original taxes.
•  Optional $250K penalty assessment by IRS for tax evasion.

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TAKE AWAYS
• Standard is subjective – makes it a tricky ethical issue for lawyers
• Government prefers employee status
• Back up a decision to make someone a contractor by making a file, contract, etc.
and know there’s a risk
• Government most often finds out via an obstructed claim, but there are many
ways
• Recent indications show government is only going to get more strict in
enforcement
VI. Wrap Up

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RESOURCES
VI. Wrap Up
Nolo Press book: “Hiring Independent Contractors”
EDD Website: go to “For Employers”
DLSE Website: go to Frequently Asked Questions and look
under “Payroll Taxes”
Diana’s Website: dianamaierlaw.com
Diana’s Blog: dianamaierlaw.com/employment-and-privacy-
law-blog-by-diana-maier

A Modern Look at Contractors v. Employees

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