Misclassification of Independent Contracts - A Controversial Issue
One of the most controversial issues many San Diego employers face is allegations of the misclassification of independent contractors by workers, state agencies such as the Employment Development Department or EDD, the California Labor Commissioner and federal agencies including the IRS. One of the primary issues which arise during an IRS audit or a California tax audit are questions regarding the misclassification of independent contractors which the agencies believe should be “employees.” While the present administration has relaxed this avenue for the time being at the US Department of Labor, the IRS and California state agencies continue to pursue independent contractor misclassification aggressively.
How Will I Come to Their Attention?
1099 workers and independent contractors become suspect of misclassification in many ways but the 3 primary methods are:
- Complaint by the independent contractor to a state or federal labor agency regarding benefits or overtime
- EDD audit – every 3 years the EDD audits most companies with workers; First question they will ask is “Tell us about any 1099 workers you have.”
- IRS audit – the IRS is constantly searching for new revenues and it is easy for them to target 1099 workers through their internal systems
It may not be a question of “if” but more a question of “when” that knock will come at your door.
What is the Cost of Misclassification of Independent Contractors?
The California civil penalty for misclassification of independent contracts is up to $25,000 per “employee” along with back pay, overtime, compensation for non-provided benefits as well as all payroll related taxes, unemployment and workers compensation. The reality for most businesses is over six figures per employee, in many cases representing the end of the company.
IRS and California EDD Audits Identify Independent Contractor Misclassification
The IRS and California agencies such as the Employment Development Department or EDD are auditing California employers in search of “employees” the agencies believe are misclassified as independent contractors.
The Department of Labor recently announced the addition of more than 100 auditors who were hired specifically to search for companies who are suspected of misclassification of independent contractors.
All federal and state agencies are looking for additional tax revenue. If an agency can establish misclassified employment status, it opens the door for back payroll taxes, penalties and interest. The numbers can be staggering. The federal and state agencies are cooperating with each other when misclassification of employees is found. It is especially important to realize this when dealing with one agency, for as soon as the first audit is completed, the next knock on the door will be from the other. Settling too soon may seem like a relatively minor issue in the California audit, until the IRS auditors call looking for ten times that amount or more.
Here in California, the EDD will conduct a “status audit” which is their term for an audit seeking misclassified employees who have been paid as independent contractors. If you have been contacted by the EDD, the IRS or the Department of Labor regarding an audit it is important to immediately contact the experienced attorneys at Allen Barron. We have extensive experience dealing with IRS audits, EDD and agency audits, and are prepared to aggressively protect and defend your interests.
How Does a Misclassification Audit or Status Audit Begin?
Usually, the misclassification of independent contractors case begins when a company is forced to lay off or end the relationship with an independent contractor. The person heads to the EDD, seeking to file an unemployment claim. The employee feeds information about your company and business practices to the EDD, and the next thing you know the case has been referred to the fraud division and your business is contacted regarding their intention to audit your business.
What are the Penalties for Misclassifying Employees as Independent Contractors?
California passed a bill in 2011 regarding the willful misclassification of independent contractors. The penalty for each instance is between $5,000 and $55,000 per instance in a civil penalty, which increases to $10,000 to $25,000 per instance if the agency believes the company in question followed a pattern of behavior over time. In addition, the “employer” would be compelled to pay unpaid overtime, meal and rest break violations, back payroll taxes, unemployment insurance, disability insurance, workers compensation insurance, FICA, benefits and even retirement matching contributions for three years.
Allen Barron Represents Businesses Audited for Misclassifying Independent Contractors
The penalties for misclassifying employees as independent contractors are draconian. If you have been contacted by the IRS, the Department of Labor or the California EDD regarding an audit or a “status audit” contact Allen Barron immediately, or call 866-631-3470 for a free and substantive consultation. Learn about the protections of the attorney-client privilege and how we can help to reduce your exposure and protect your legal and financial interests.
What Can Allen Barron Do to Protect Me?
The best defense is a good offense. We help clients to come into compliance with the “tests” employed by the EDD to determine the question of “employee” or “independent contractor.”
We help to structure the agreements and policies which ensure the necessary separation between your company and your independent contractors.
Once a complaint or lawsuit is filed we aggressively represent businesses in misclassification of independent contractors hearings, audits and lawsuits. We present documentation and argue the law and remind them of the limitations of that law.
For example, one of our clients ran a part-time company which hired independent for individual projects which lasted a week or two. Each independent contractor had a unique skill, and contributed their skills to the project. There were substantial time gaps between projects, but contractors provided similar work on many separate projects over time.
The EDD and the IRS attempted to argue the independent contractors were actually employees, even though there were often weeks between engagements and some were more complex than others. Allen Barron’s attorneys, tax and accounting professionals fought the battle from a tax perspective, an accounting perspective and a legal perspective, ultimately triumphing after a long drawn out process.
Resources
Downloads
Practices Areas
Contact Us To Learn More About Allen Barron's Services
For more information or to discuss your tax, legal and accounting needs contact Allen Barron or call 866-631-3470 for a free and confidential initial consultation. Learn about the importance of integrated business strategy and coordination across legal, tax and accounting systems.
Offices of Allen Barron, Inc.
Main Office
16745 West Bernardo Drive, Suite 260
San Diego, CA 92127
Phone: 858-304-0947
Phone: 866-631-3470
Fax: 858-376-1410
San Diego Office
5720 Oberlin Drive
San Diego, CA 92121
Phone: 866-631-3470
Fax: 760-741-1410
Las Vegas Office
333 South Sixth Street, Suite 230
Las Vegas, NV 89101
Phone: 702-749-4430
Fax: 702-933-1748
San Diego Office
750 B Street, Suite 2610
San Diego, CA 92101
Phone: 619-702-8356
Fax: 619-923-8356
San Francisco Office
300 Montgomery Street, Suite 410
San Francisco, CA 94101
Phone: 415-481-0475
Fax: 415-762-1539
Phoenix Office
40 North Central Avenue
Phoenix, AZ 85004
Phone: 602-903-7018
Fax: 602-357-1655