Independent Contractors v. Employees

Independent Contractors v. Employees A Practical Guide for Parents Who Hire Household Help Diana Maier Attorney-At-Law 1

AGENDA Why do I need to know the difference between an independent contractor and an employee when hiring or contracting with household help? How do I know if my household worker is an independent contractor or an employee? What are the benefits of each? How does the government know (or find out about) my contractor/employee? What are the penalties if I get it wrong? What can I do to protect myself once I ve determined how to pay my service provider? And if my household worker is an employee, what else do I need to know to stay in compliance with the law? Closing Thoughts Summary and Evaluations 2

WHY DO I NEED TO KNOW THE DIFFERENCE BETWEEN AN INDEPENDENT CONTRACTOR AND AN EMPLOYEE? Anytime you pay someone for services the government will ask you to consider your relationship with the service provider. As a rule of thumb the government wants you to treat the people you pay as employees (As an employer you provide for your employee: you pay things like unemployment and social security taxes, and get worker s compensation insurance for the person providing services. It s a big expense for you, and nice income for the government. The government therefore makes you pay if you get it wrong.) and you ll hope to treat them as independent contractors (When you pay your service provider as a contractor you save money in terms of taxes, administrative work, and legal liability.) 3

HOW DO YOU KNOW WHO IS WHICH? Informal or unstated factors which have proven to matter: Does the service provider bill by the job or the hour? Do you have a short-term relationship with her? Does she hold herself out as a business? Does she Advertize? Use business cards? Did she negotiate her fees, or did you tell her what you d pay? Does she exercise control over how she does the work? Did she play a role in deciding the amount the payment (e.g. telling you it would cost X amount to give you Y product)? Does she have other employers? (If yes make a file) (note: The government will assume someone working full-time in your home is an employee, unless they come from third-party agency). 4

WHAT ARE THE ADVANTAGES OF WORKING WITH AN INDEPENDENT CONTRACTOR? Ease It s the easiest route for a short-term service provider because you simply pay an hourly fee and that s the extent of your obligation. Save Money No mandated contributions (state and federal unemployment tax, social security) No Discretionary fringe benefits (medical insurance, vacation time, etc) or mandatory benefits (SF sick leave) No mandated worker s comp coverage Administrative savings Minimizes Liability Requires less record keeping/reporting 5

WHAT ARE THE DISADVANTAGES OF CLASSIFYING YOUR HELP AS AN INDEPENDENT CONTRACTOR? Steep penalties if you get it wrong (and get caught) Government Presumes Employee Status: any person rendering service for another, other than as an independent contractor, is an employee. Labor Code section 3357 Less Control: By definition, you aren t exercising control over a contractor, so it requires a hands-off approach. (Particular disadvantage for nannies/babysitters, as most parents want control over how their children are cared for) It s risky. The government finds virtually everyone to be an employee 6

FORMAL FACTORS, OR WHAT THE GOVERNMENT AGENCIES SAY MATTERS... The EDD Standard - Employment Development Department (CA Common Law) Uses the California Common Law in determining action Asks: Does the principal have the right to direct and control the manner and means by which the work is performed? When the principal has the "right of control, the worker will be an employee even if the principal never actually exercises the control. If the principal does not have the right of direction and control, the worker will generally be an independent contractor. 7

FORMAL FACTORS (MORE AGENCY EXAMPLES) DLSE Standard - Division of Labor Standards Enforcement Starts with the presumption that the worker is an employee (Labor Code Section 3357). Rebuttable presumption and determination depends upon a number of factors. 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 the worker both as to the work done and the manner and means in which it is performed. In other words it s a subjective test. 8

FORMAL FACTORS (MORE AGENCY EXAMPLES) Workers Compensation Board Any person rendering service for another, other than an independent contractor, is presumed to be an employee. (Lab C 3357) The test used is based on Borello 9

ADDITIONAL FACTORS IN BORELLO CASE: Are the services performed in an occupation or business distinct from that of the principal? (not a relevant factor with most household employees) Is the work part of the regular business of the principal or alleged employer? ((N/A) Who supplies the instrumentalities, tools, and the place? What is the workers 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? Is the work usually done under the direction of the principal (i.e. you) 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? 10

ADDITIONAL FACTORS IN BORELLO CASE: 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 is NOT determinative since this is a question of law based on objective tests. (Borello, Id.at 349) 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, and (3) The nature of the work makes detailed control unnecessary. (Yellow Cab Cooperative v. Workers Compensation Appeals Board (1991) 226 Cal.App.3d 1288) 11

HOW DOES THE GOVERNMENT KNOW WHO YOU VE CLASSIFIED AS WHICH? (AND DECIDE TO INTERVENE?) AUDITS: The CA Employment Development Department conducts audits of businesses or individuals claiming independent contractor-principal relationships. These audits usually arise when an individual who has been treated as an independent contractor files for unemployment benefits. AKA 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 SHARED INFORMATION: Joint task force between EDD and DLSE IRS: The IRS discovers the misclassification when it audits you GOVERNMENT TARGETS AND SYSTEMATICALLY AUDITS A PARTICULAR INDUSTRY (E.G. Beauty Salons) 12

WHAT ARE THE PENALTIES FOR MISCLASSIFYING? Tax Penalties If an employer fails to withhold or make employment tax payments for the worker, then liable for such payments, including penalties and interest. IRC 3402(g). 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. However, failure to withhold or pay California taxes will result in the same penalty whether or not the employee was intentionally or unintentionally misclassified. 13

WHAT ARE THE PENALTIES FOR MISCLASSIFYING? EDD Sanctions The EDD may impose several liabilities and penalty assessments including income tax, unemployment insurance contributions, state disability insurance, interest, penalties of up to 10%, and possible criminal penalties 14

WHAT ARE THE PENALTIES FOR MISCLASSIFYING? CA Workers Compensation Penalties If the workers compensation board reclassifies a worker as an employee, the employer who misclassified the worker as an independent contractor may be subject to: 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) 15

WHAT ARE THE PENALTIES FOR MISCLASSIFYING? Liability for minimum wage and overtime An employer who erroneously classifies a worker as a independent contractor who is later classified as an employee may be liable for several wage and hour penalties and liabilities: Minimum wage and overtime amounts the employer should have paid (Lab C 1197). Huge one for nannies. 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) Meal and rest break penalties Attorney Fees and Costs (Lab C 1193) 16

CASE #1 A small company decides that it doesn t need to classify two service providers as employees, and for three years pays each 60K a year or 360K total. If both the EDD and IRS audit and reclassify the workers as employees, the assessment will be as follows: Unintentional Misclassification and 1099 filed: 79K Unintentional Misclassification and no 1099 filed: 86K Intentional Misclassification: 146K-174K 17

IF YOU DECIDE TO PAY YOUR WORKER AS A CONTRACTOR, WHAT SHOULD YOU DO? Build a vendor file that says they are an independent contractor (file business cards, copies of invoices, advertisements and other indication of business) Don t tell contractor how long to stay or 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 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 18

IF YOU DECIDE TO PAY YOUR WORKER AS AN EMPLOYEE, WHAT SHOULD YOU DO? Get an Employer Identification Number (EIN); report employee Pay at least minimum wage; give meal and rest breaks Workers Compensation/Social Security Tax (FICA), Federal Unemployment Tax (FUTA), and more (however only pay FICA taxes if worker is paid more than $1600 yearly, and FUTA if paid more than $1000 per any quarter). Do not need to withhold income taxes unless employee requests it (household workers only). Make sure you are paying your employee in a legally sustainable way See counsel to be sure you are complying with the very tricky wage and hour laws (e.g. time and a half for overtime; meal and rest breaks) Find reliable resources to help you assess your exposure to lawsuits, etc. Self-audit available, for example, on www.dianamaierlaw.com Consider hiring a payroll service, or an agency such as Breedlove for babysitters/nannies 19

HOW DO I PAY MY EMPLOYEE? The standard in California is 1.5 times the hourly rate at anything over 8 hours a day, 40 hours a week. Some employees are exempt from overtime: Exempt from overtime rate (employer pays one rate regardless of amount of hours worked): Nanny or Babysitter (in some circumstances): Must perform services on an irregular or intermittent basis rather than vocation, i.e. not more than 20 hours in the week; can t depend on it for her livelihood. In most other cases, nannies not exempt but this is a hot area in the law and may change/ is not crystal clear at this point. Lose it if 20% of duties or more are housekeeping not related to the child care. Personal Attendant or Domestic Companions Untrained personnel (not nurses, medical assistants, etc) providing fellowship, care, and protection for a person who can t care for him/herself because of age. (In California, nannies, etc. also considered personal attendants but taking into account the fact that federal law doesn t unequivocally grant the same status, err on side of assuming not a personal attendant.) Employer loses exemption (i.e. must pay overtime) if person spends 20% of her time or more on general household duties. 20

HOW DO I PAY MY EMPLOYEE? Pseudo-Exempt from Overtime Au Pairs/Housekeepers, etc. who live in house No need to pay overtime if live-in has at least 12 consecutive hours free of duty during each workday of 24 hours, and the total span of working hours is no more than 12 hours and: (1) Employee has at least three (3) hours free of duty during the 12 working hours. Such off-duty hours need not be consecutive, and the schedule for same shall be set by mutual agreement of employer and employee. However, an employee who is required or permitted to work during scheduled off-duty hours or during the 12 consecutive off-duty hours without the three hour break shall be compensated at the rate of one and one-half (1½) times the employee's regular rate of pay for all such hours worked. (2) Employee is not required to work more than 5 days in any one workweek without a day off of, and is not required to work 24 consecutive hours except in an emergency. However, an employee must be compensated for time worked in excess of 5 workdays in any workweek at one and one-half (1½) times the employee's regular rate of pay for hours worked up to and including nine hours. Time after nine hours on 6 th and 7 th day, you must pay double. 21

HOW DO I PAY MY EMPLOYEE? Not Exempt from Overtime Non live-in: Housekeeper Gardener Home Accountant Bookkeeper, etc. 22

Standard is subjective. SUMMARY Government prefers employee status. Back up a decision to make someone a contractor Know you ll only get away with it for so long if you make a full-time household worker an independent contractor. Government most often finds out about misclassification via an obstructed claim. If you have an employee, get help following employment laws, particularly wage and hour If you have an employee, consider outsourcing payroll and compliance issues 23

RESOURCES Nolo Press, Hiring Independent Contractors EDD Website go to For Employers or http://www.edd.ca.gov/payroll_taxes/am_i_required_to_register_as_an_employer.htm DLSE Website go to Frequently Asked Questions and look under Payroll Taxes IRS publication 926; Household Employer s Tax Guide Breedlove; The Nanny Tax Company; Homework Solutions Law Offices of Diana Maier Private counsel: Provide contracts to support independent contractor status Tools/Free Resources on website www.dianamaierlaw.com In case of an employee, provide counsel on complying with California law, particularly wage and hour 24

DIANA MAIER: THANK YOU FOR COMING! Investigator Small Business Auditor (Employment Law) Trainer Litigator HOW I CAN HELP YOU: IC Contracts Getting set up for an employee Specific counsel on an employee/contractor situation Assessing your legal health as an employer Investigate employee complaints TELEPHONE: 415.515.1707 EMAIL: diana@dianamaierlaw.com 25