A recent court case reaffirms employee status changes and tax impact for California companies who have 1099 workers. This case confirmed updates to California law regarding employees vs 1099 workers is retroactive. The consequences for any California employer determining to be misclassifying employees as 1099 workers during an EDD audit are financially daunting. We’ve been watching developments in these cases since the landmark decision handed down by the California Supreme Court in 2019 known as the “Dynamex” decision.
Generally speaking a California employer must classify their workers either as an “employee” or as an “independent contractor.” California applies an “A-B-C” test to determine if a 1099 worker should actually be classified as an employee.
Based upon recent legislation signed into law last year and the recent court case an employer must demonstrate a 1099 worker:
- Control – The 1099 worker must be free from control and/or direction in performance of their work, and
- Focus – The 1099 worker must be performing work for other sources and not simply working for the company claiming them as a 1099 worker, and
- Historical Experience – The 1099 worker has performed similar work in the past for other companies, is focused on a specific type of work and was already performing this work in general before taking on tasks assigned by the company who has claims them as a 1099 worker
The employee status changes and tax impact for California employers creates significant financial exposure for any employer who is determined to have misclassified employees as 1099 workers. The IRS will issue a penalty of 1.5% of any wages paid to a misclassified independent contractor. This fine is doubled to 3% if a 1099 for that worker was not filed with the IRS. In addition, the employer is immediately responsible for all federal income taxes which should have been withheld from the misclassified “employee” as well as Medicare and Social Security taxes.
California tax agencies such as the EDD and FTB have heavy penalties they can and will impose as well. California law establishes a civil penalty between $5,000 and $25,000 per violation (based on the agency’s determination of the scope of the employer’s conduct). If there is a “pattern” of 1099 violation, the fines are immediately increased to be $10,000 to $25,000 per incidence. An employer found to have misclassified employees as 1099 workers will also have to pay all unpaid California payroll taxes and an additional 10% penalty. California will also require the employer to pay all associated workers compensation and unemployment taxes which should have been collected from the “employee.”
Finally, the “employee” themselves is entitled to file a lawsuit to seek and individual or class-action lawsuit seeking vacation pay, unpaid overtime wages as well as the monetary value of any benefits which would have been provided to an “employee” during their term of work.
The risks associated with status changes and tax impact for California employers from an EDD or FTB audit are quite severe. In addition to the civil fines and back taxes above, an employer found to be in purposeful violation of the law may face criminal charges as well.
If you are an employer facing an audit from a tax agency such as the EDD or FTB you will need experienced, proven representation from an Allen Barron tax attorney to protect your interests in the audit and prepare strategies to help mitigate any circumstances which might arise.
We invite you to contact Allen Barron today or call 866-631-3470 to schedule a free consultation.