California employers must be very careful not to misclassify employees as independent contractors. Governor Brown recently signed into law two very important statutes that impose penalties against employers who misclassify employees as independent contractors. The new laws, which go into effect on January 1, 2012, let the state go after employers who intentionally misclassifies an employee as an independent contractor for penalties up to $25,000 per violation.
Labor Code section 226.8 – Penalties for misclassification of independent contractors
This new statute, which goes into effect on January 1, 2012, reads as follows:
(a) It is unlawful for any person or employer to engage in any of the following activities:
(1) Willful misclassification of an employee as an independent contractor.
(2) Charging an employee who has been willfully misclassified as an independent contractor a fee, or making any deductions from compensation, for any purpose, including for goods, materials, space rental, services, government licenses, repairs, equipment maintenance, or fines arising from the employee’s employment where the employer would have been in violation of the law if the employee had not been misclassified.
(b) If the Labor and Workforce Development Agency, or any of its departments, divisions, commissions, boards, or agencies, or a court finds that person has engaged in any of the enumerated violations of subdivision (a), a civil penalty of not less than five thousand dollars ($5,000) and not more than fifteen thousand dollars ($15,000) shall be assessed against the person for each violation, in addition to any other penalties or fines permitted by law.
(c) If the Labor and Workforce Development Agency, or any of its departments, divisions, commissions, boards, or agencies, or a court finds that person has engaged in any of the enumerated violations of this section and there is evidence that the person has engaged in or is engaging in a pattern or practice of these behaviors, a civil penalty of not less than ten thousand dollars ($10,000) and not more than twenty-five thousand dollars ($25,000) shall be assessed against the person for each violation, in addition to any other penalties or fines permitted by law.
(d) For purposes of this section, “willful” means voluntary and intentional.
(e) Nothing in this section is intended to limit any rights or remedies otherwise available at law.
Background of Independent Contractor Misclassifications
An employer cannot wilfully (i.e., voluntarily and intentionally) make someone an independent contractor when that person would really be an employee. The misclassification of an employee as an independent contractor can have many negative effects on the person and society in general. First, true independent contractors are not eligible for overtime pay, unemployment benefits, and Workers’ Compensation benefits. They cannot bring actions before the Labor Commissioner for unpaid wages. They cannot collect a penalty under Labor Code section 203 for the wilful non-payment of wages owed (i.e., a penalty of 30 days of pay). Critically, a true independent contractor cannot sue his/her employer for non-payment of wages under the California Labor Code, meaning that the employee would not be able to an award of attorney’s fees and costs at the conclusion of his/her case. This often results in independent contractors being somewhat helpless in efforts to collect wages that they are owed. But if the employee is truly an employee, but was misclassified as an independent contractor, then the employee would be able to all the benefits of being an employee under California law.
While the legislature likely took the effect of a misclassified employee into account when drafting this new law, it is more likely that the legislature was concerned with the effect on society. Specifically, taxes. It is not required that employers pay payroll taxes on wages paid to independent contractors. It is also not required that employers make normal deductions from the wages paid to independent contractors: Medicare, Social Security Disability Insurance, Workers’ Compensation Insurance, Unemployment Insurance. In short, the non-payment of these taxes results in untold amounts of lost income to the state. Given that the misclassification of employees as independent contractors is more common in these days of a struggling job market, it is no wonder that the legislature stepped up to plug this loophole.
Effect on Misclassified Employees
If you are reading this, you likely do not care why the new law exists. You are wondering whether the new law could mean more money in your pocket. The answer is not simple. The penalties assessed by the new statute are recoverable by the state, not individuals. That means that the state (i.e., the Labor and Workforce Development Agency) needs to come in and assess the penalty against the employer, and the penalty goes to the state once it is collected.
However, a mechanism exists whereby an employee would be able to collect a portion of the penalties. Individuals can bring representative actions on behalf of all other misclassified employees at their workplace under the Private Attorneys General Act (“PAGA”) to recover civil penalties that are normally assessed by the Labor and Workforce Development Agency or the Labor Commissioner. The individual must bring the PAGA action in civil court and sue to recover the penalties for the state. The individual must give 75% of the recovered penalties to the state. The individual would then split the remaining 25% with the other affected misclassified independent contractors.
Effect on Employers
Employers need to be extra careful to not misclassify employees as independent contractors. If, say, they get a decision at the EDD stating that one of their supposed contractors was really an employee, and there are other persons similarly misclassified, it could put the employer in a very difficult situation, because it would likely be found that keeping the folks as independent contractors after the EDD’s decision was “willful” under the statute. That could open the employer up for liability for the penalties.
Labor Code section 2753
This new statute, which also takes effect on January 1, 2012, states as follows:
(a) A person who, for money or other valuable consideration, knowingly advises an employer to treat an individual as an independent contractor to avoid employee status for that individual shall be jointly and severally liable with the employer if the individual is found not to be an independent contractor.
(b) This section does not apply to the following persons: (1) A person who provides advice to his or her employer. (2) An attorney authorized to practice law in California or another United States jurisdiction who provides legal advice in the course of the practice of law.
Effect on Accountants
The new Labor Code section 2753 is raising quite a stir amongst my accountant friends. Accountants must be extra careful not to advise their clients to treat employees as independent contractors, because an accountant who does so could be liable for the penalty to be imposed under the new Labor Code section 226.8. If I were an accountant, I would automatically refer questions about classifying employees as independent contractors to an employment lawyer, because only a lawyer is exempted from liability under this new statute.