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For a variety of reasons, companies often engage full-time service providers as independent contractors (ICs) rather than employees.  Recently, much attention has been paid to incorrect IC classifications in the construction industry, the “service economy” and within the supply chains of larger companies (delivery drivers, shipping and receiving, and the like).  But full-time, white-collar employees at companies of all stripes are also incorrectly labeled ICs with startling frequency.

For example, some companies have a policy of labeling all new hires as ICs for their first few months of employment and then transitioning them to employees if, and only if, they “fit” the culture.  Some startups simply call everyone an IC for as long as they think they can get away with it.  This article identifies the basic rights that “misclassified” ICs have under California law.  It also provides ICs with some suggestions on how to leverage their incorrect classification into a better economic outcome.

Why A Worker’s Classification Matters

Being classified as an IC has a number of disadvantages for the IC.  First, an IC must pay self-employment taxes that exceed the amounts their employer would have withheld from their paychecks.  Second, employees—but not ICs—are entitled to the protections of the California Labor Code, the California Family Rights Act (CFRA), the Fair Employment and Housing Act (FEHA), and numerous other laws that apply only to employees.  Third, whereas employees are eligible to receive grants of incentive stock options (ISOs) which carry significant tax advantages, ICs are not.  Fourth, ICs are rarely covered by workers’ compensation insurance policies, eligible to receive employer-sponsored healthcare, or participate in retirement plans.  Finally, ICs cannot take advantage of state-subsidies to employees who take leaves of absence as a result of child birth, illness, injury, or to take care of a family-member.

An “Independent Contractor” Label Is Not Controlling

The label a company applies to its relationship with a given individual is not controlling.  Rather, someone who is classified as an IC is entitled to the legal rights of an employee upon a showing that applicable law required that classification.  S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341, 349, (1989); Ruiz v. Affinity Logistics Corp., 754 F. 3d 1093, 1101 (9th Cir. 2014).  Whether a given IC has been correctly classified depends on a number of factors that vary slightly depending on the law that is being applied.   But, one rule of thumb is that service providers who work full-time, under some supervision and are not engaged in a specialized trade or business generally should be classified as employees.  See Labor Code § 3357; 29 U.S.C. 203(e).

Misclassified ICs Are Entitled To Various Wage & Hour Protections

The California Labor Code provides employees with numerous rights in the wage and hour arena.  Thus, a misclassified independent contractor is entitled to the following (and may sue for damages and penalties if they are not provided):

  • Indemnification or reimbursement for all job-related expenses (Labor Code § 2802)
  • Overtime pay (unless an exemption applies)
  • Daily, unpaid meal periods (unless an exemption applies)
  • Daily, paid rest periods (unless an exemption applies)
  • Itemized wage statements during every pay period
  • Penalties of $5,000-$25,000 in the event the misclassification is willful (Labor Code § 226.8)
  • Penalties under PAGA and Labor Code § 558

Employers May Not Retaliate Against A Misclassified ICs For Complaining About Their Status

In addition, a misclassified IC who complains to an employer about an incorrect classification (or any other unlawful conduct) will be protected by the Labor Code’s anti-retaliation provisions, including Labor Code §§ 98.6 and 1102.5.  A misclassified IC who seeks to be classified as an employee and then is retaliated against will have all the same rights an employee does.  Indeed, there would be a strong inference of retaliatory motive if an employer terminated a misclassified IC’s contract shortly after a receiving a complaint regarding their classification.  The same inference would apply if the misclassified IC was demoted or otherwise harmed shortly after a discussion concerning their classification.

Misclassified ICs May Recover Under Other Miscellaneous Labor Code Sections

The Labor Code also provides rights that go beyond the wage and hour arena.  Here are a few examples that may be relevant to misclassified ICs:

  • Salespersons must receive detailed, written commission agreements (Labor Code § 2751)
  • Employees cannot be required to pay a fee to apply for a job (Labor Code § 450) or undergo a required pre-employment medical exam (Labor Code § 222.5)
  • Treble damages related to an employer’s inaccurate statements about an employee in the context of a reference check (Labor Code § 1050 et seq.)
  • Double damages if an employer induces an employee to move by making a false representation regarding the kind, character, or existence of available work (Labor Code § 970 et seq.)

Right To Recover The Extra Taxes The IC Paid

A final common complaint made by misclassified ICs is that they paid more in self-employment taxes than would have been withheld from their paychecks if they had been treated as employees.  A related issue occurs when the IC is unaware of the requirement that they pay self-employment taxes and are liable for late payment penalties.  Although there is not a lot of case law on the topic, employees will frequently seek—and receive—payment for these taxes and penalties based on common law theories like fraud and misrepresentation (regarding the employer’s statements to the employee regarding the classification), negligence (regarding the employer’s decision to make the employee an IC), and breach of the implied covenant of good faith and fair (with respect to the IC agreement).

Key Sources Of Leverage Over Employer

Misclassifying an IC can expose employers to the liabilities set forth above.  Accordingly, misclassified ICs have leverage in two main contexts.  First, ICs who are departing an employer are in an excellent position to negotiate separation benefits that make them whole for the benefits they lost as a result of their improper classification.  Second, misclassified ICs who want to transition to positions as employees can make such a request knowing that if their employer refuses they are protected under the anti-retaliation provisions of the Labor Code.

For any number of reasons, however, an IC may not be focused on becoming an employee or want to risk being dismissed.  In that situation it may be best to sit tight.  In sum, every situation may present any number of nuances.  If you would like to discuss your particular situation or this post more generally, then please contact Sebastian Miller.

Disclaimer: All materials have been prepared for general information purposes only to permit you to learn more about Sebastian Miller Law, P.C, its services and experience.  The information presented is not legal advice, is not to be acted on as such, may not be current and is subject to change without notice.