CONSEQUENCES OF
EMPLOYEE MISCLASSIFICATION

Boards are tempted to classify workers as independent contractors so they can save money by avoiding payroll taxes, health benefits, and workers' compensation insurance. They also avoid benefits like paid sick leave, vacation, or health insurance. Instead, they write the person a check and file a 1099 income form if the check is over $600. However, to do so now is more risky due to the federal government's implementation of its new initiative: Questionable Employment Tax Practice (QETP).

Consequences of Misclassification. Under QETP, federal and state auditors scrutinize independent contractor agreements. Whenever there is a question about a worker's classification, governmental agencies start with the presumption that the worker is an employee as defined by Labor Code §3357. If these auditors determine that a worker is improperly classified, the employer may be required to pay penalties, including the following:

• Federal and state income tax for the previous three years;

• Employee's share of Federal Insurance Contributions Act (FICA) taxes and the employer's matching amount;

• Federal unemployment taxes of 6.2% of each employee's compensation up to $7,000.00, and state unemployment insurance equal to 3.4% of compensation up to $7,000.00; and

• 0.5% of the total amount of the debt per month for up to 50 months (6% annually) with the possibility of additional penalties for substantial understatement or fraud (applicable in cases where the employer failed to file correct information returns, furnish correct payroll statements, and comply with information reporting requirements).

Factors for Determining Status. There are a number of factors used to determine whether a worker is an employee or an independent contractor. Following are some of the factors used to evaluate a worker's status:

1. Does the association train the worker on his/her job?

2. Is the worker required to personally render services or can the worker assign them to others?

3. Does the association allow the worker to establish his/her own work hours?

4. Is the worker allowed to turn down assignments without penalty?

5. Is the worker invited to regular employee meetings or functions?

6. Was the worker given an employee manual?

7. Are business and/or traveling expenses reimbursed?

8. Does the association provide benefits, such as health insurance, vacation or sick days?

9. Does the association provide the worker with tools, equipment or other supplies?

10. Is the method of payment hourly, weekly, monthly (as opposed to commission or by the job?)

11. Does the worker make his/her services available to the general public?

No one factor is conclusive, but, as a general rule, a worker is an independent contractor when the association has the right to control only the result of the work and not the means or methods of performing the work. See IRS Publication 1779

Example. Painters are generally classified as independent contractors because they are hired on a project basis; supply their own painting supplies and equipment; and do not have set working hours where they need to clock in and out. In other words, the painters control the process. However, not all painters are independent contractors. Some (i) work solely for one association and do not seek or advertise for additional work; (ii) the association controls the means by which the painting is performed by instructing the painters where, when, and how to paint; and (iii) the association supplies the painters with supplies. Such painters are employees, not independent contractors.

Avoiding Misclassification. To avoid misclassification, associations should limit the use of "full-time" independent contractors, and instead hire workers on a specific project basis. Additionally, associations should treat workers similarly in similar situations. In other words, if the job duties of two employees are the same or similar, do not hire one as an independent contractor and the other as a W-2 employee. Further, keep employment relationships consistent. Do not convert an independent contractor to a W-2 employee status. Last, use independent contractor agreements that highlight the components of independent contractor status so as to withstand the scrutiny of federal and state auditors.

Updated by ADAMS KESSLER 8/9/2008