Boards are tempted to classify workers as independent contractors so they can save money by avoiding payroll taxes, health benefits, and workers' compensation insurance. They also avoid benefits like paid sick leave, vacation, or health insurance. Instead, they write the person a check and file a 1099 income form if the check is over $600. In 2018, the California Supreme Court adopted a more stringent test for determining whether individuals are employees or independent contractors. Previously, there was no presumption of status and multiple factors were used to determine whether an individual was an independent contractor. Now, an individual is presumed to be an employee and the burden is on employers to show otherwise. (Dynamex Operations West v. Sup. Ct.)
The ABC Test. In 2019, the legislature codified the strict "ABC" test for employee versus independent contractor classification adopted by the California Supreme Court in the Dynamex case. All workers are presumptively considered employees and may only be classified as independent contractors if the hiring business demonstrates the worker satisfies each of three conditions:
- the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact,
- the worker performs work that is outside the usual course of the hiring entity's business, and
- the worker is customarily engaged in an independently established trade, occupation, or business. The hiring entity's failure to prove any one of these three prerequisites will be sufficient in itself to establish that the worker is an employee, rather than independent contractor.
On January 10, 2024, the U.S. Department of Labor issued a final rule, Employee or Independent Contractor Classification Under the Fair Labor Standards Act, effective March 11, 2024. This final rule revises the Department’s guidance on how to analyze who is an employee or independent contractor under the Fair Labor Standards Act (FLSA). An FAQ guide for the new rule is at : https://www.dol.gov/agencies/whd/flsa/misclassification/rulemaking/faqs. This final rule continues to affirm that a worker is not an independent contractor if they are, as matter of economic reality, economically dependent on an employer for work. Consistent with judicial precedent and the Department’s interpretive guidance prior to 2021, the final rule applies the following six factors to analyze employee or independent contractor status under the FLSA:
- opportunity for profit or loss depending on managerial skill;
- investments by the worker and the potential employer;
- degree of permanence of the work relationship;
- nature and degree of control;
- extent to which the work performed is an integral part of the potential employer’s business; and
- skill and initiative.
The final rule provides detailed guidance regarding the application of each of these six factors. No factor or set of factors among this list of six has a predetermined weight, and additional factors may be relevant if such factors in some way indicate whether the worker is in business for themself (i.e., an independent contractor), as opposed to being economically dependent on the employer for work (i.e., an employee under the FLSA).
Consequences of Misclassification. Under QETP, federal and state auditors scrutinize independent contractor agreements. Whenever there is a question about a worker's classification, governmental agencies start with the presumption that the worker is an employee. If an auditor determines a worker is improperly classified, the employer may be required to pay penalties, including the following:
- Federal and state income tax for the previous three years;
- Employee's share of Federal Insurance Contributions Act (FICA) taxes and the employer's matching amount;
- Federal unemployment taxes of 6.2% of each employee's compensation up to $7,000.00, and state unemployment insurance equal to 3.4% of compensation up to $7,000.00; and
- 0.5% of the total amount of the debt per month for up to 50 months (6% annually) with the possibility of additional penalties for substantial understatement or fraud (applicable in cases where the employer failed to file correct information returns, furnish correct payroll statements, and comply with information reporting requirements).
Avoiding Misclassification. To avoid misclassification, associations should limit the use of "full-time" independent contractors, and instead hire workers on a specific project basis. Additionally, associations should treat workers similarly in similar situations. In other words, if the job duties of two employees are the same or similar, do not hire one as an independent contractor and the other as a W-2 employee. Further, keep employment relationships consistent. Do not convert an independent contractor to a W-2 employee status. Last, use independent contractor agreements that highlight the components of independent contractor status so as to withstand the scrutiny of federal and state auditors.
ASSISTANCE: Associations needing legal assistance can contact us. To stay current with issues affecting community associations, subscribe to the Davis-Stirling Newsletter.