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Thursday, May 17, 2012
Department: June 2009
Employee or Contractor?
When independent contractors don’t pass the plumber test
Story by Bill Romanelli
As the economic beatings continue, one consideration that inevitably arises within organizations is whether to reclassify some or all employees as “independent contractors” to cut costs.
No doubt, shedding expenses associated with payroll taxes, workers’ compensation insurance, health benefits and other costs can look attractive, but employment law experts warn that it’s not as simple as it sounds. Worse, if you do it wrong, the consequences to your business can be severe, if not crippling.
“The first thing I tell clients is that they need to be extremely cautious,” says Eli Makus, attorney with Hanson Bridgett LLP in Sacramento. “It can be a quagmire with a host of different state and federal rules, and it can be dangerous if it’s done simply as a cost-cutting measure.”
The federal government and the state of California both have a complex set of factors they consider in evaluating whether someone is a contractor or an employee, and meeting the requirements of one set of rules does not mean you’ve automatically met the requirements of the other. In both arenas, employers should know the odds are against them.
“It’s very difficult for an employer who has previously classified workers as employees to reclassify them as independent contractors,” says Bob Roginson, chief counsel in the Division of Labor Standards Enforcement for the California Department of Industrial Relations. “For starters, there’s a presumption of employment in California. Employers have the burden of establishing that a worker can be a contractor.”
The Internal Revenue Service has a list of several questions it considers in analyzing employees versus contractors at irs.gov. Among these, there is some overlap with the factors California examines. For example, both the feds and the state focus on how much control an employer has over workers. Do they dictate the hours workers are on the job or how the work is conducted, and to what degree are the workers supervised? Generally, the more control an employer has or exerts, the more likely the workers involved would be considered employees.
“Bottom line, a decision to reclassify employees should not be taken lightly,
given the risks involved.”
— Eli Makus, attorney, Hanson Bridgett LLP
Other considerations include whether the worker could perform the same tasks for other clients. For example, if the organization provides all the tools and equipment needed to perform the job, including things such as a laptop, PDA or company car, it’s likely that person will be classified as an employee. Likewise, employers must demonstrate the person isn’t performing work that could be considered central to the organization’s mission.
“In a hospital, you can contract out cleaning the floors, but it’s hard to contract out medical or nursing care,” says Bruce Sarchet, attorney with Littler Mendelson PC in Stockton. “Another thing I use is the ‘plumber test.’ If the person is to your company what a plumber is to your household — meaning they set their own hours, use their own equipment, work without supervision and then go on to the next place and do the same thing — that’s a contractor.”
No two situations are alike, however, and there are no cookie-cutter approaches to reclassifying workers. Companies should only proceed on this course if they have had the benefit of good legal counsel and have considered all the various factors involved. Failing to do it correctly could lead, at best, to a severe financial sting and, at worst, to a bet-the-business proposition.
“Under state law, the statute of limitations could be as long as four years,” Makus says. “In some situations a business could be liable for unpaid overtime as well as missed meal and rest periods, along with a host of penalties and fines applicable for every day of the entire four years. Multiply that by the number of workers, and it adds up fast.”
Some of those penalties and fines result from improperly withholding payroll taxes and failure to provide workers’ compensation insurance. Regulators could even order the business to cease operations altogether — at substantial cost — until insurance is provided.
As an illustration of how serious violations can be, the Department of Industrial Relations recently obtained a $13 million judgment against a janitorial company that had misclassified its employees
Worst of all, the business could be liable under Business and Professions Code Section 17200, also known as the state’s Unfair Competition Law. If a civil action is brought against the company, it will likely include an unfair competition claim, which could call for restitution, attorneys’ fees and perhaps even disgorgement of profits. What makes this threat particularly sobering is that a claim need not be brought by an affected worker. A business competitor or any other entity that can prove injury due to the organization’s unfair practice of misclassifying workers as contractors could bring an unfair competition lawsuit.
“Bottom line, a decision to reclassify employees should not be taken lightly, given the risks involved,” Makus says. “It has to be motivated by a change in your overall business strategy and not just a desire to cut costs.”
