Employee or Independent Contractor – Who is Who in California? (Part 2)

In the last post (here) we talked about Steve.  Is he an independent contractor or an employee?  Some of you straight-to-the-bottom-line types may be asking, “What’s the point?  Why does it matter?”  This blog’s for you.

Most, if not all, problems arise when you, the business owner, treats Steve like an independent contractor when he’s really an employee (see part one to find out how to make that determination).  You may have made this decision intentionally as a cost -savings measure, or maybe you didn’t fully understand of how the system works.  Either way, there are two main reasons why it’s important to categorize Steve correctly:

1. It can cost you money with your insurance companies.
2. It can cost you money (or even potentially jail time) with the state.

(Yes, I wrote jail time.  Sorry for the strong language.  I’m not trying to be a scaremonger, but there are situations where this is true.  I’ll explain.)

First, the insurance companies.

When you call Steve an independent contractor when he’s really an employee you can pay a hefty sum at the time of your final audit on your various business insurance policies.  Here are some examples to explain what I’m talking about:

• At the end of your policy term, your Workers Comp company will conduct a final audit.  They will consider Steve an employee which will require that you include the amount you paid him as payroll.  They kindly ask for additional premium to be paid in full.  If they’re nice, they’ll allow financing.
• Your General Liability, depending on what type of business you are, may base the premium on your payroll or employee count.  Like your Workers Comp company, it will conduct a final audit, asking for more money out of you based on Steve’s existence and/or payroll.  If you’re a contractor, it is more likely that your General Liability policy is based on employee count and/or payroll than other types of businesses.
• Employment Practices Liability Insurance premium is also based on employee count.  If you have it (and you should), because of the existence of Steve as an employee, you will get stuck with a bill at your final audit.  If you’re not sure what EPLI is, check out my blog here.

Note: if you only have one Steve, these bills at final audit may not be such a big deal… but what if you have two Steves?  Three?  Four?  A dozen?  Final audits can get extreme.

The other insurance issue you can experience because of a miscategorization of Steve is a darker problem, and it’s that of having no coverage when you really wish you did.  This one will hit you harder when you are a small business and Steve is your only employee.  In the end, it will cost you more money than you may realize.  What am I talking about?  Here’s an example:

• Because you believe Steve is an independent contractor, you never got Workers Comp insurance.  Steve gets injured and wants to file a Workers Comp claim.  Uh-oh: no coverage.  The problem gets worse when Steve gets a lawyer.  If you do have other employees and a Workers Comp policy in place, the problem of coverage does not exist for you because Steve will merely be treated like the employee that he is and get his injuries paid for.  Solo business owners, beware!

Next: the State of California – an even darker problem than any that arises from the insurance companies.

California doesn’t like workers to not receive the benefits that are due, and it doesn’t like to not receive tax revenue that it is owed.  So, what happens when Steve is erroneously categorized as an independent contractor?

• Steve can file a wage claim with the state of California or merely find a lawyer and sue you for all the benefits that he’s entitled to receive as your employee. The benefits include unpaid wages (such as overtime, commissions, bonuses, paid sick days, and paid vacation days), rest periods, meal breaks, and more.  See here for more detail: www.dir.ca.gov/dlse/HowToFileWageClaim.htm.
• California will want its taxes.  If it is revealed to the state that you haven’t been paying Steve’s payroll taxes, California will politely ask you to pay.
• If Steve gets injured on the job, files a Workers Comp claim as an employee, but you don’t have insurance, you could be subject to up to a year in jail!  (This is the proof that I wasn’t making up the jail time situation).  I quote: “failure to secure workers’ compensation insurance is a misdemeanor punishable by imprisonment in the county jail for up to one year, or by a fine of up to ten thousand dollars ($10,000) or by both that imprisonment and fine. (Labor Code Section 3700.5).”  Source: www.dir.ca.gov/dwc/faqs.html#5
• Lastly, I’m no expert on health insurance so I’ll bring up a potential issue: if you have group health for your employees, but didn’t offer it to Steve because you thought he was an independent contractor, you might not be in compliance with the Affordable Care Act.  Any health pros want to chime in on this?

As you can see, there are some serious problems when your worker is categorized as an independent contractor when he really is an employee.  What, then, can you do to protect yourself and avoid confusing Steve – an employee – for an independent contractor?  There are two steps as far as I can see:

1. Before utilizing the service of anyone in your business operation, know which category he or she falls into (see the first blog I wrote on this).
2. Correctly categorize your worker as soon as he or she begins working for you.