According to the California Labor Code §3353, an independent contractor refers to any individual who renders a service for a specified sum of money. Thay act for a particular project under the control of a principal, but only as to the result of the project and not the means in which the individual completes the project.
In other words, if you work for someone on a freelance basis or are hired under a contract for a specific purpose and are not considered an employee, then you are most likely considered an independent contractor. This is especially true if you are essentially your own boss and are in charge of how you approach an assignment.
Some examples of independent contractors include freelance writers, real estate agents, freelance graphic designers, and construction workers.
Whether you own a business or are hiring someone to get a special type of assignment done, an independent contractor is a great way to save a lot of money. With an independent contractor, you will not have to pay for unemployment insurance, workers’ compensation, sick leave, health insurance, or payroll costs like you would if you hire an employee instead.
Working with an independent contractor also helps to decrease your risk of exposure to possible lawsuits. However, while an independent contractor could still potentially sue you for an injury suffered on the job or for harassment, they generally cannot sue you for employment discrimination or wrongful termination. This is because they lack most of the employment rights that are granted to employees under the law.
Are There Special Tax Requirements Under California Law If I Hire an Independent Contractor?
As of January 2020, a new law entitled Assembly Bill 5 (“AB 5”) went into effect, which requires employers in California to treat independent contractors as standard employees unless they satisfy a three-part test. The test, known as the “ABC test”, establishes whether a worker should be classified as an employee or an independent contractor under the new law.
The three prongs of the ABC test are as follows:
- First, the worker must be free from the direction and control of the hiring entity in regard to performance of the work;
- Second, the worker must perform work that is considered to be outside of the standard course of business conducted by the hiring entity; and
- Third, the worker must ordinarily be engaged in an independently established business, occupation, or trade of the same nature as that associated with the work performed.
Accordingly, if a worker does not meet all three requirements in the above list, then they will be classified as an employee and not as an independent contractor. The reason why it is so important for hiring persons to know exactly how to classify workers is because their classification will dictate what benefits they can receive and what types of tax documents will be needed to report, file, and pay taxes for both federal and state tax purposes.
For instance, if a worker is classified as an employee, then the hiring entity will need to provide them with a Form W-2, withhold both federal and state income taxes from their paychecks, and pay for state unemployment insurance and employment training taxes, among many other responsibilities.
On the other hand, if the worker is classified as an independent contractor, then the hiring entity will need to provide them with a Form 1099-MISC instead. However, they will not have to withhold certain items from their paychecks like Social Security or Medicare since the worker will be responsible for paying federal self-employment taxes, which includes both.
In addition, a worker can be classified as a federal independent contractor, but a California state employee. Thus, hiring entities will need to figure out how to classify their workers. Also, in some cases, an employer may need to report a new independent contractor to the Employment Development Department within 20 days, depending on if the following three statements apply to the circumstances:
- The employer is required to file a Form 1099-MISC for the work performed by the independent contractor;
- The independent contractor will either be paid $600 or more for their services, or will enter into a contract for $600 or more for their services; and
- The independent contractor is either an individual or sole proprietorship.
Finally, it is important to note that if an employer misclassifies a worker as an independent contractor, then they may be assessed for wage violations. If the employer intentionally or willfully misclassifies a worker as an independent contractor, then they can also receive civil fines, ranging between $5,000 to $25,000 per violation.
What Is My Tax Liability as a California Employer?
As discussed above, it is crucial that a California employer correctly classify the people they hire as either employees or independent contractors. Employers who incorrectly identify their workers may be held liable for wage violations. They will also have to pay any amount of unpaid taxes that they would have initially had to pay had they classified the worker correctly in the first place. They may also receive civil fines if their misclassification was done willfully.
For example, in California, every employer during their first year of business is required to pay employment training taxes, which works out to approximately $7 per each employee. If the employer fails to deposit and report these taxes (e.g., payroll taxes), then the employer can be charged with a misdemeanor, may receive a fine of up to $1,000, and/or can be sentenced to jail for up to one full year. This is true even if the employer fails to deposit them by mistake.
The penalty imposed if a California employer is late on making their payroll tax payments is 15% on the amount that is owed. This percentage can increase to 25% if the employer underpays or fails to payroll taxes at all, unless the employer can show that it was an honest mistake and not tax fraud.
In addition, because employers are responsible for reporting federal and state taxes, they may be audited by both federal and state agencies, as well as can be issued two separate sets of legal penalties.
Should I Contact A California Attorney For My Employment Issue?
Employment issues, especially tax-related ones, can be a headache for both workers and employers. Thus, if you are a worker or an employer who is experiencing employment issues, then it may be in your best interest to consult a California business attorney as soon as possible. Preferably, it should be one who has experience in handling employment and tax-related issues.
A qualified business attorney who practices in California will be able to explain and can answer any questions you may have about the new requirements under the recently enacted state labor laws.
Depending on your situation, your attorney can ensure that you classify your workers correctly as either independent contractors or employees. Alternatively, if you are a worker, your attorney can make sure that your employer has you on their payroll under the proper label. Your attorney can also discuss your tax requirements and check that you are reporting and making accurate payments in accordance with both state and federal tax laws.
In addition, if you are being sued by a worker or are being audited by a government tax agency, your attorney will be able to represent you at any case-related meetings or in court should it become necessary. Regardless of whether you are an employer or a worker, you should seek out legal representation if you or your employer has violated the law.