Independent Contractor or Employee?

It's all about control.

Before California will accept your classification of a service provider as an independent contractor and not an employee, you must pass two hurtles:

The first is the Borello test, which has been the law of the land in California since 1989.  It uses 10 weighted factors.  The principal one is whether the hiring person has the right to control the manner and means of accomplishing the desired result, whether or not that right is exercised.  Other factors include:

  • The worker performs work that  is not part of the hiring person/company's regular business
  • He is engaged in what is customarily an independent trade
  • He is employed just to perform a certain one-time task or contract
  • He sets his own hours
  • He may hire people to assist him
  • He works for other people at the same time he works for the hiring person/company
  • He has a business, as evidenced by a business license
  • He already has all of the knowledge & skills necessary
  • He provides all of the supplies, equipment, vehicles, etc.

If the relationship passes the Borello test, there is still the new California AB 5 law which took effect on January 1, 2020.  It instituted the "ABC Test".  Unlike the Borello test, where some factors can point one way and others point another way, all 3 parts of the ABC test must be satisfied to qualify for independent contractor status.

  • The worker is free from the control and direction of the hiring entity in connection with the performance of the work
  • The work performed is outside the usual course of the hiring entity's business (this is the factor that most often points to employee status)
  • The worker is engaged in an independently established trade, occupation, or business of the same nature as the work performed

There are many, many, many exceptions from the ABC test for specific occupations.  But the Borello test still applies.

What if you've been misclassifying workers?

The liability is significant:  $5,000 to $15,000 per violation, plus unpaid taxes, penalties and interest. You may also be held responsible for taxes which should have been withheld from the employee's pay.    Even for a very small payroll, this can total several tens of thousands of dollars.  Licensed contractors will be reported to the Contractors' State Licensing Board.

If you've been misclassifying workers, consider the IRS Fresh Start Initiative.  It offers reduced rates and penalties.  But the state does not have an amnesty program.

An important note:  If you are paying a California nonresident (someone who has a non-California address) as an independent contractor, you must with hold 7% of everything above $1500 per year and send it to the State.

Also important:  an officer of a corporation is almost always an employee, not an independent contractor, even if his compensation is based on sales or some other performance measurement.

The California Employment Development Department has a handy checklist which can help you determine if the EDD would consider your worker an independent contractor.

The information above is a general outline.  If you'd like to enlist the services of an experienced CPA tax accountant, please contact me.

M Bess Kane, CPA
November, 2020