Stiff New Penalties for Misclassification of Independent Contractors

There has been a trend in recent years for companies to treat workers as independent contractors in order to avoid the administrative responsibilities and extra costs applicable to employees (payroll taxes, workers' compensation insurance, unemployment insurance, overtime pay, and various employee benefits). In response, both the Internal Revenue Service and state agencies have stepped up compliance audits to check whether businesses are properly classifying their workers. An employer who has made incorrect classifications faces an array of governmental fines and penalties, as well as liability to the misclassified workers.

California has raised the stakes with a new law, effective January 1, 2012, which adds Sections 226.8 and 2753 to the Labor Code. Section 226.8 prohibits any person or employer from willfully misclassifying an individual as an independent contractor, or from making any charges or compensation deductions (eg, for goods, materials, or space rental) to such individual if it would be unlawful to make such charges or deductions to an employee. Section 226.8 imposes penalties of $ 5,000 to $ 25,000 for each violation.

The law does not specify how often a "violation" is deemed to occur, leaving open the possibility that multiple penalties could be assessed with regard to a single worker. A willful misclassification is defined as one that is "voluntary and knowing." It is not clear how this standard will be interpreted by the courts.

Section 226.8 also requires any employer found to have violated the law to display prominently on its website for one year a specified notice relating to the violation.

Violations of the law by licensed contractors will be reported to the Contractors' State License Board, which will initiate disciplinary action against the contractor.

Under Section 2753, a person who, for money or other valuable consideration, knowingly advises an employer to treat an individual as …

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