Introduction
Hiring independent contractors is somewhat tricky. Businesses must abide by the laws that allow them to classify a worker as an independent contractor. If the employer cannot comply with the legal standards for proper worker classification, it may be in breach of the law.
The variations between these arrangements could have significant effects for firms and people alike.
This piece will cover the main differences between an employee and an independent contractor in California. We will discuss how to tell the difference & why it matters if you are mistakenly classified. The legal framework for paying contractors in California will also be covered.
The main difference between Independent Contractors & Employees
In California, independent contractors and employees are often distinguished by whether or not the entity contracting for services has the authority to regulate or control the means and procedures of labor (tending to infer an employment connection).
Or if the person providing the services has made the unilateral decision to launch their own company (showing an independent contractor relationship).
Determining each type can be particularly difficult because the legal system & federal and state agencies may utilize different definitions, criteria, and components to determine independent contractor or worker status depending on the circumstances.
For example, an employer must consider that the IRS employs common law categories of independent contractor & employee when determining what kind of IRS tax forms to produce.
The “economic reality” criterion is used to evaluate a worker’s status in federal lawsuits. There are some differences between this strategy and this categorization approach.
However, when the judicial system is asked to determine whether a worker is entitled to the protection of California’s non-discrimination rules, state law plus a different set of circumstances would be taken into account.
Disparities between Independent Contractors and Employees in California
When deciding whether a worker is an employee or an independent contractor, California courts apply a variety of standards.
The standards for claims under California’s wage and hour laws differ from those under the state’s workers’ compensation statutes. The following are ascertained using these standards:
- The benefits of unemployment insurance.
- Disability insurance.
- State withholding of income tax.
State and federal legislation may employ various specific tests, but the elements of such tests often turn out to be confusingly identical to one another.
They may even overlap or recur.
Furthermore, applying the relevant criteria in any one of these approaches to the particulars of a given incident may be extremely fact-specific.
A worker may be classified as an independent contractor under certain conditions or as an employee under others.
A worker may even be categorized as an independent contractor for the purposes of paying taxes with the IRS. California’s wage and hour laws classify them as employees, though.
The California Supreme Court’s recent decision in Dynamex vs. Superior Court (Los Angeles) resolves some of the ambiguity surrounding the laws and situations that are pertinent to wage & hour statutes, but it leaves other concerns unresolved.
California’s Independent Contractor Law
Independent contractors have more “flexibility” than regular employees in theory.
Someone who works for themselves instead of an employer or boss is sometimes referred to as an independent contractor.
Independent contractors in California have been free to establish their own hours and locations, set their own prices, have many clients, own their own tools and supplies, provide particular skills or information that are not frequently provided by a company, etc.
In other words, an independent contractor is responsible for themselves.
A company may hire an independent contractor to perform certain activities, but this does not immediately make the contractor an employee.
In California, determining whether a worker is an employee or a freelancer depends on how much power they have over their employer.
Control enhances the likelihood that an individual will be classified as an employee. On the other hand, the more independent a person is, the more likely they are to be a contractor.
The disadvantages of independent contractors
Despite having greater control, independent contractors are not granted the same privileges as employees according to California law.
They can be fired much more easily and are not entitled to overtime pay or even the basic salary. They may be required to work long, nonstop shifts without getting paid more.
Independent contractors do not get the coverage of unemployment insurance. They are not protected by state & federal legislation (anti-discrimination).
Employees’ Benefits
Employees are protected by state & federal laws. They include the right to overtime, the necessity that they earn at least the minimum wage, & qualification for unemployment insurance.
Other benefits and protections available to employees but not to independent contractors include:
- Health and retirement benefits.
- FICA tax responsibilities.
- Workers’ compensation coverage.
Essentially, being incorrectly classified as an independent contractor when carrying out the responsibilities of an employee constitutes a serious violation of your rights.
In addition to losing your basic rights as an employee, this incorrect classification could cost you a substantial amount of money.
Independent Contractors in California
Currently, about 53 million people are classified as independent contractors. A large number of these staff members have not been sufficiently identified.
Businesses can attempt to save money by misclassifying their employees as independent contractors. They are not obligated to provide as many benefits and protections by doing so. Strict compliance is required when paying contractors.
How should one evaluate an independent contractor with an employee in California?
You are probably employed if:
- You get paid on an hourly basis.
- You are a full-time employee of the company.
- The business keeps a careful eye on you.
- The organization provided you with training.
- As an employee, you are entitled to perks.
- Your company provides the necessary tools and equipment for the job.
- The business’s operations depend on the services you provide.
- You are regular, which means that you seem more like an employee the more regular you are.
You don’t have to meet every need mentioned above in order to work, even though these are useful indicators. Please consult an experienced employment law specialist to be sure of your classification.
Most likely, you work as an independent contractor if:
- Your remuneration is determined by your task.
- You set your own hours for working.
- You supply the tools and materials needed to perform your job.
- You work for several companies at the same time.
- You are responsible for paying for your business and travel expenses.
- You hire and pay your own assistants.
- You could make money or lose money working with the company.
- You operate an entirely independent business.
Please contact a lawyer if you have any questions regarding whether you are an employee or an independent contractor under California law.
Many businesses take advantage of the ambiguity surrounding these two categories to avoid their obligations related to paying contractors. It’s not always easy to distinguish between them. California has specific rules governing paying contractors under contractual agreements.
Industries Most Affected by Independent Contractor Misclassification
Misclassification of independent contractors occurs in every industry. Some people are more susceptible than others.
Misclassification of independent contractors is often more common in some industries. According to the National Employment Law Project’s research on the topic:
- Construction
- Technology & Computers
- Real Estate
- Drivers
- Janitorial
- Home Care
Uber is a San Francisco-based driving service. It is a recent and well-known instance of an employee-independent contractor misclassification controversy.
Uber has maintained that its drivers are independent contractors because they drive their own cars, set their own hours, and work without supervision.
Several states have maintained Uber’s classification in cases where drivers have challenged it. A recent verdict by California’s Labor Commissioner mandates that Uber drivers be treated as employees.
They receive equipment (iPhones) from Uber. Uses customer reviews to monitor their performance. Decides on rates of compensation and costs without considering the drivers. Didn’t employ the drivers due to their unusual abilities.
Are you misclassified?
Workers who are incorrectly classified may be owed thousands of dollars. It is for underpaid minimum wages or overlooked overtime compensation.
It may be difficult to determine your true categorization. Being an independent contractor or an employee is not determined by a single factor.
Conflicts may still arise even when the legal system takes into account all relevant information while determining the appropriate classification.
You may be eligible for reimbursement if you think your designation as an independent contractor was inaccurate.
Related Read: What To Do If Misclassified as Independent Contractor?
Why Does It Matter If You’re Misclassified?
The question of whether an individual in California is legally an employee or an independent contractor can have an impact on the resolution of many other legal challenges.
It is therefore frequently the most important threshold question in employment cases.
California Employers’ Obligations to Employees
According to federal as well as state law, employers have a wide range of obligations to people who are classified as employees.
These include abstaining from discrimination, refraining from retaliation, paying contractors minimum wages, paying taxes and insurance (such as workers’ compensation, social security, and unemployment benefits), meeting minimum safety requirements, and following other rules like a minimum salary, overtime pay, meal breaks, & rest periods.
California Independent Contractor Payment Regulations
Rules around paying contractors are complex. Unlike employees, independent contractors are not always entitled to overtime or minimum wage payments under California’s independent contractor compensation requirements.
These contractors are allowed to speak with their clients directly about employment agreements, customary rates, or terms of payment; these details are often incorporated in a legally binding contract. A company must ensure compliance when it is paying contractors.
Adherence to Independent Contractor Regulations
California has certain regulations regarding the classification of independent contractors. Businesses must properly follow these rules and regulations. They will be able to avoid legal issues with worker classification.
Independent contractors are responsible for all risks and duties related to their work, in addition to paying their own payroll taxes and self-employment taxes.
Employers may be motivated to take one of two steps to avoid the costs and obligations associated with being an employer.
They will:
Mistakenly classify employees as independent contractors.
Try to restructure their employment relationships as independent contractor arrangements through intricate measures.
The Dynamex Case
The court recognized in the Dynamex case that “when a person is simply labeled an independent contractor via a unilateral decision of an employment entity, but has not autonomously elected to function in an independently created company.”
However, there’s a good likelihood that the employer is attempting to evade the demands of a pertinent wage order by using misclassification.
Employers and employees are not the only parties affected by this. The state loses more than $7 billion in unpaid payroll taxes every year. This is a result of employees being misrepresented as independent contractors.
IRS Forms W-2 & 1099: Are they Necessary for Independent Contractors?
Any business organization hiring a worker is required by federal law, in compliance with the federal tax regulations, to determine the extent of the business connection—whether a self-employed worker or an employee—at the beginning.
Federal tax law mandates that employers prepare and provide an IRS Form W-2 to their employees.
Instead, a company would submit an IRS Form 1099-MISC (independent contractors).
The IRS applies common law standards to determine whether an individual is an employed person or an independent contractor.
The common law norm mandates that every bit of evidence pertaining to the degree of autonomy and power in the link be examined.
The data would be examined in light of the following three categories:
1. Control of Behavior
How much power does the company have? Is it able to determine what should be accomplished and how? Either by instruction, training, or other means.
An individual is much more likely to be an employee if they have to complete responsibilities in a certain way at a given time and place.
If the organization that is receiving services provides training on the necessary procedures and methods, this indicates that the organization wants the work done in a particular way. Again, this kind of person is much more inclined to be classified as an employee.
2. Monetary Regulation
To what extent does the firm control the financial aspects of an employee’s work?
- Is there any company expense for the employee? We can expect an independent contractor to pay their own expenses.
- Does the worker invest in the facilities and equipment?
- Does the worker make their services available to the relevant market or the general public? If this happens, it would suggest a self-employed individual.
- How does the company pay its employees? To get payment for certain services, a self-employed individual can, for example, share invoices. An employee may receive a regular check.
- Will the employee profit or lose money? A person is in business if they have the ability to make or lose money.
Compliance is mandatory when paying contractors.
3. The relationship between the parties
How do the two parties view their relationship?
- Are the parties’ desired types of relationships outlined in formal contracts? Remember that this element is more important in the context of IRS rules than it is in California wage and hour laws. According to California wage & hour regulations, the existence of an agreement identifying the partnership as an independent contractor is not taken into consideration. The IRS may be significantly impacted.
- Are there benefits for the workers? Health insurance, a pension plan, earned time off, & leave for illness. This implies a relationship between the employer & the employee.
- A relationship that is expected to be long-lasting & continuous defines an employer-employee relationship.
- What is the reliance of the hiring company’s everyday operations on the individual? A company doing overnight or same-day delivery service hired a driver. A driver offering delivery services is doing a task that would be crucial to the day-to-day operations of the hiring business.
Evaluating Employment Status on IRS Form SS-8
If you are not sure whether you or the worker should be classified as W-2 or 1099 for federal tax withholding reasons, you can ask the IRS to make that determination.
Use IRS Form SS-8 to provide a request.
The IRS will select a technician to review your Form SS-8, administer the rules, and render a decision after receiving it.
It can require up to six months.
Laws pertaining to employment might be somewhat confusing. Getting legal advice helps.
The Dynamex ruling & the ABC test in California law
The decision made by the California Supreme Court marked a dramatic change in how California courts will resolve the employee-independent contractor dispute going forward.
The decision really created a standard that, unless the employer can demonstrate otherwise, presumes that workers are employees in claims filed according to the state’s wage orders.
The Dynamex Decision: California’s Independent Contractor vs. Employee
In California, Dynamex has several offices. It serves as a courier service provider.
Up until 2004, Dynamex regarded its drivers in California as workers.
However, Dynamex changed its relationship with carriers in 2004 in an effort to save money.
Dynamex’s approach after 2004 was to treat drivers as independent freelancers who were responsible for providing their own vehicles and paying for their own transportation expenses, including gasoline, maintenance, and liability insurance.
Drivers were nevertheless obliged to wear Dynamex shirts & badges, as well as occasionally apply Dynamex stickers to their vehicles.
Drivers were free to choose their own routes and delivery timetables in addition to employing people and delivering goods for various delivery companies.
Two of the drivers filed a class-action lawsuit (2005). They claimed that they and other drivers were mistakenly classified as independent contractors. Dynamex had violated the California Labor Code and state wage orders.
The California Supreme Court was asked to rule on whether the trial court’s certification of the case as a class action was acceptable.
The question at hand concerned whether the judge (trial court) had established the proper cutoff point for classifying workers as independent contractors or employees when certifying the class-action status of the case.
The California Supreme Court decided that the trial tribunal’s use of the very broad employment terminology in the wage orders was acceptable for worker classification.
A wage order: What is it?
Labor laws include wage orders. They outline the requirements for pay, hours worked, and working conditions in specific industries. Wage orders are “quasi-legal procedures that have the impact of law and are authorized by the Constitution.”
Wage guidelines are issued by the Department of Industrial Relations.
An independent contractor is not precisely defined in the wage orders.
Rather, the directives usually say that the rules “apply to all personnel working” in the concerned organization, with a handful of exceptions.
“Employee” in Wage Orders: Three Interpretations
The broad description of an employee is “any person who is employed by the company.” In a prior case, Martinez v. Combs, the wage orders established three different definitions of employment: (a) to exercise control on the hours, salary, or workplace standards; (b) to fulfill a responsibility (suffer) or consent to work; or (c) to take part, creating a common law connection of employment.
Any distinction between independent contractors can be fully absorbed by the “suffer or permitted to labor” concept, and these definitions are undoubtedly quite broad.
The Independent Contractor ABC Test in California
The California ABC test states:
A California employee who is legally considered an independent contractor is not subject to a pay order unless the recruiting body demonstrates each one of the following:
(A) The employee is not subject to the recruiter’s control or guidance for the completion of the assignment, both according to the terms of the agreement for the carrying out of such task and in actuality.
(B) The worker performs duties that are not normally part of the employing entity’s operations; and
(C) The worker frequently works in a profession, trade, or business that is separately established and comparable to the work performed for the recruiting company.
What About Lawsuits Submitted Under California’s Labor Code or Fair Employment & Housing Act?
The question of whether a comparable criterion applied in such types of circumstances was not expressly addressed by the court in Dynamex.
As a result, it is still uncertain whether the ABC analysis and the presumption of a work link might or ought to be applied in circumstances apart from wage orders.
However, the Dynamex Court did point out that when it comes to the question of whether workers should be categorized as independent contractors or employees, the standard common law norm that had been established in S.G. Borello & Sons against the Department of Industrial Relations does not constitute the only suitable examination.
Instead, the Court determined that a statutory purpose standard must be utilized to determine which aspects “best achieve the underlying legislative meaning and intent of the legal system at issue.”
This gives future courts a strong foundation on which to conclude that the statutory objectives of the Labor Code (California) & Fair Employment and Housing Act require the use of the broader “suffer or permitted to work” norm and the assumption of a relationship involving employment that goes along with it.
1. Independent Contractors Are Not Protected
The distinction between employees & independent contractors is crucial. FEHA’s anti-discrimination regulations apply to employees as opposed to independent contractors.
“Persons delivering services pursuant to a contract” are protected from discrimination under the FEHA. They are not protected from unlawful harassment.
According to FEHA, a “person providing services pursuant to an agreement” is someone who meets all of the following criteria:
- The person has the power to control and choose how the services agreement will be performed.
- The person usually works for a self-owned business.
- The person completes activities requiring a particular skill that isn’t usually employed in the employer’s field of business.
- He provides the materials and tools needed for the job.
- He has control over the time & places of work.
2. The Fair Labor Standards Act’s “Economic Realities” test in California: Independent Contractor vs. Employee
When attempting to determine the proper classification of a worker, a court in California may need to apply federal law in specific circumstances.
The IRS employs common law standards to figure out whether an organization is an independent contractor or an employee-employer, although the federal Fair Labor Standards Act does not.
3. The FLSA test is commonly referred to as the “Economic Realities” test
The following components are considered significant under “Economic Realities”:
- The significance of the services to the business of the principal. “Principal” in this sense basically refers to the company that hires the worker.
- The longevity of the connection.
- The amount of money the defendant contractor spent on structures and equipment.
- The degree and kind of control exercised by the principal.
- The claimed contractor’s possible profit and loss.
- The degree to which independent companies are established and operated.
However, some situations are not taken into account by the economic reality assessment.
The Economic Realities Test does not give any weight to the following factors:
- The place where the work is completed.
- The presence or absence of a formal employment contract.
- The time and mode of payment.
- If a supposed independent contractor possesses a license from the state or municipal government
The “Economic Realities” test is rarely applied in California because the state’s Fair Employment and Housing Act, Labor Code, and pay standards are often significantly more advantageous to workers than the FLSA.
The Dynamex decision shifted the scales in support of workers in California.
Misclassification & Penalties
Similar to the numerous circumstances in which an independent contractor’s or employee’s designation becomes vital, an employer may be subject to a number of penalties for misclassification, and an employee who is misclassified may be able to pursue damages in a number of ways.
1. Penalties
Section 226.8 of the California Labor Code forbids employers from purposefully misclassifying an individual as an independent contractor.
Employers who intentionally misclassify may be subject to a civil fine of five thousand dollars to fifteen thousand dollars from the Labor and Workforce Development Agency.
The term “willful misclassification” refers to the purposeful and voluntary misclassification of an individual as an independent contractor for the purpose of avoiding their status as an employee.
If the Labor and Workforce Development Agency or a court of law finds that an employer engaged in a “standard or practice” of infractions, the employer may be subject to civil fines varying from ten thousand dollars to 25 thousand dollars for each misclassification infringement. California laws governing paying contractors are strict.
The IRS may apply even harsher fines.
A felony charge, a penalty of up to $100,000, and a potential sentence of five years in prison await anyone who willfully attempts to avoid or dodge any tax under the Code of Internal Revenue by incorrectly identifying an employee as an independent contractor.
2. Employee remedies
Workers who were mistakenly classified as independent contractors but should have been classified as employees are eligible for payment for all benefits they would have earned if their classification had been accurate.
These advantages may include interest and back pay because of:
- Rest periods, insufficient minimum wage, overtime compensation, and/or missed lunch breaks.
- Reimbursement for court costs and legal fees might additionally be available to employees.
- An unemployment claim (insurance) from a terminated employee who was incorrectly classified as an independent contractor may be accepted by the Employment Development Department (EDD).
- The company may be fined if the EDD determines that the worker was incorrectly classified. The worker could still be qualified for unemployment benefits.
- Similarly, misclassified workers who get hurt on the job may still file a claim with the Workers’ Compensation Division of the Department of Industrial Relations.
- Employers without insurance risk fines of up to $10,000 and/or imprisonment for a year.
Freelance Worker Protection Act
A law that considerably expands rights for independent contractors was passed in California. When hiring some independent contractors, private companies must give them a formal contract with specific terms and pay them within set timeframes. The goal of the new law is to provide freelancers with “basic employment rights” and the right to timely payment.
Who Has to Adhere?
Contracts covered by the FWPA (Freelance Worker Protection Act) apply to:
- A “freelance worker” & a “hiring party.”
- Signed or extended on or after 1st January 2025.
The following are important terms to be aware of:
An individual or entity in the State of California that hires a freelancer to perform professional services is referred to as a hiring party.
A person contracted or retained by a hiring party as a legitimate independent contractor to offer professional services in return for $250 or more is considered a freelancer (either from one agreement or when combining every agreement between the independent contractor and the same hiring party over the last 120 days).
The term “professional services” refers to services like human resources, marketing, travel agency services, grant writing, graphic design, photography, fine artistry, photo editing, videography, freelance writing, illustrating, translating, editing, and more that are covered by California’s historic independent contractor law, AB 5.
What Requirements Does the FWPA Have?
1. Written Agreements
According to the FWPA, the hiring party must give the freelancer an official copy of a written agreement. It should be in hard form or digital form. Retain a copy of the agreement for a minimum of four years. The written contract needs to contain some mandatory details. Contracts define the process of paying contractors.
- Each party’s name and address.
- A broken-down list of every service that will be rendered, together with the services’ worth, rate, and mode of payment.
- The date or method by which the hiring entity will pay the fee.
- The deadline by which the freelancer must provide the employing party with a list of services completed in accordance with the contract to fulfill the hiring party’s internal requirements for prompt payment of remuneration.
For employing parties to safeguard themselves in the event of disagreements over services or payment, written contracts are essential. According to the FWPA, the parties’ acts and conversations can serve as proof that an agreement was formed even in the absence of a written agreement.
Even if an agreement wasn’t ever written on paper, actions and conversations, such as negotiating the cost for work with the independent worker or the individual finishing the duties they were supposed to, can serve as proof that it was created.
2. On-time Payment
The FWPA mandates compensation for covered freelancers:
- Before or on the date of payment indicated in the contract.
- In the absence of a payment date stipulated in the contract, no later than thirty days following the completion of the services rendered by the independent contractor.
What Is Prohibited Under the FWPA?
1. Retaliation and Discrimination
An employing party is prohibited by the FWPA from discriminating against or taking any unfavorable action against a freelancer that penalizes or is likely to discourage the freelancer from engaging in any of the following:
- Opposing any activity that the FWPA forbids.
- Taking part in any actions pertaining to FWPA enforcement.
- Attempting to uphold any rights granted to them under the FWPA.
- Claiming or making an effort to claim rights granted under the FWPA.
2. Modifying Conditions to Ensure On-Time Payment
After a freelancer begins working under an agreement, the hiring party cannot demand that the freelancer fulfill the following requirements to be paid on time:
- Accept less money than what was agreed upon in the contract.
- Offer more products or services, or grant additional intellectual property rights.
How is the FWPA going to be enforced?
A freelancer may file a lawsuit to uphold the law and obtain the following:
- The freelancer will receive an extra $1,000 if they asked for a formal contract before starting work & the hiring company declined.
- The freelancer has the right to collect up to double the money that was not paid when it was due if the hiring organization did not pay them the agreed-upon compensation within the allotted period.
- The amount owed will be calculated using the fee that the freelancer reasonably believed applied to the work if they asked for a written agreement before starting work & the hiring organization refused to give one.
- The freelancer may get damages equivalent to the contract’s worth or the worth of the job completed, whichever is higher, if the hiring organization breaches any of this law’s provisions.
Five Easy Steps to Comply
It is essential for businesses to comprehend their responsibilities under the new law because the FWPA will apply to nearly all private employers who recruit or keep independent contractors for specialized services. You can comply by following these five steps:
- Decide which suppliers would be considered by the FWPA as having been freelance workers.
- Check on existing contracts with vendors and contractors to ensure that they address the new specifications and amend contracts where required.
- Provide protection to independent contractors. It should be under existing anti-discrimination and retaliation policies.
- Educate your hiring supervisors on the new regulations.
- Pay freelancers on time in line with the terms of the contract or, in the absence of a specific payment date, within thirty days of the freelancer finishing the services required by the contract.