Question:

In my business, I frequently retain independent contractors. I understand a new California law penalizes businesses that “willfully misclassify” employees as independent contractors. What exactly does the new law say?

Answer:

California Senate Bill 459, which becomes law on January 1, 2012, creates new and significant civil penalties for businesses that misclassify employees as independent contractors.

Under existing California law, businesses that misclassify employees as independent contractors are already subject to consequences, including liability for payroll taxes, unpaid unemployment insurance contributions, and penalties for failure to secure workers’ compensation coverage for these individuals. Furthermore, since the misclassified individuals have not been paid pursuant to wage and hour laws, they are often owed overtime and penalties for missed meal and rest periods.

In determining whether a worker is an independent contractor or an employee, many businesses believe that they are safe if they have an independent contractor agreement with the worker. That alone does not determine that the worker is an independent contractor. The most important factor is whether the business has control or the right to control the worker as to the work done and the manner and means in which it is performed. The more control the business has over the worker, the more likely the worker is an employee. Detailed information on the factors that are considered can be found on the California Department of Industrial Relations website,
http://www.dir.ca.gov/dlse/faq_independentcontractor.htm.
Now under Senate Bill 459, there is further liability for misclassification of workers. The new law authorizes civil penalties where a business either (1) willfully misclassifies an employee as an independent contractor or (2) charges an individual who has been willfully misclassified as an independent contractor a fee or makes any deductions from compensation. “Willful misclassification” is defined as “voluntarily and knowingly misclassifying” an individual as an independent contractor. In both instances, the business may be subject to civil penalties between $5,000 and $25,000 per violation, as well as other penalties or fines permitted by law.

In contrast to California’s harsh new law, the Internal Revenue Service recently announced a Voluntary Classification Settlement Program (VCSP) that enables businesses to remedy past worker misclassifications at a low cost by voluntarily reclassifying their workers as employees. Under the VCSP, the business must agree to treat the class of workers as employees (not independent contractors) for future tax periods, pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, and agree to extend the period of limitations on the assessment of employment taxes. In exchange, the business will not be liable for any interest and penalties on the federal employment tax liability and will not be audited for employment tax purposes for prior years with respect to the classification of the workers. Taxpayers can apply for the VCSP using IRS form 8952.

These new laws demonstrate the need for close scrutiny by businesses when classifying workers as employees or independent contractors. For more information on Senate Bill 459, visit
http://www.leginfo.ca.gov. For more information on the Voluntary Classification Settlement Program, visit http://www.irs.gov.
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