Independent Contractor or Employee?

Important Update:  A California Supreme Court Decision, Dynamex Operations West, Inc., may have made all of the information below obsolete.  For now, the decision applies only to the transportation industry, but I expect California to expand the new tests to all workers.  Under Dynamex, all three of these tests must be met in order to treat the worker as an independent contractor:

  1. The worker is free from control and direction of the hiring company,
  2. The worker performs work that is outside of the company's business,
  3. The worker is engaged in what is customarily an independently established trade

Is your worker your employee or an independent contractor? 

It comes down to a question of control.  If you ...

  • Employ him for an indefinite amount of time (no fixed termination date),
  • Tell him when to show up and when to quit,
  • Train him how to do the work, and
  • Provide all of the supplies, equipment, vehicles, etc.

Then he is your employee, regardless of whether he works part-time or full-time.

On the other hand, if ...

  • You employ him just to perform a certain one-time task or contract,
  • That task is not part of your regular business,
  • He sets his own hours,
  • He already has all of the knowledge & skills necessary,
  • He provides his own supplies, equipment, vehicles, etc.,
  • He may hire people to assist him,
  • He works for other people at the same time that he works for you, and
  • He has a business, as evidenced by a business license

Then he is an independent contractor

But what he doesn't fit neatly into one class or the other?  Then it's a judgement call.  How many factors point one way and how many point the other way?

What if you've been misclassifying workers?

The penalties are significant:  $5,000 to $15,000 per violation, plus penalties and interest.  Licensed contractors will be reported to the Contractors' State Licensing Board.

The IRS has an amnesty program called the Voluntary Classification Settlement Program (VCSP.)  It allows employers to (1) come forward if they are not under audit, (2) reclassify independent contractors as employees, and (3) pay an amount much, much less that what would be owed if they were discovered at audit, generally 10% of just one year to settle all years.  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
January, 2019