Misclassification. What’s the worst that can happen?
In past installments of Ask OOTB, we’ve talked about ways to classify your workers. We’ve talked about the ABC test and the Borello test, both of which are used in different circumstances to determine whether a worker should be classified as an independent contractor or an employee. However, the commercial photography industry is full of people who are used to being independent contractors. Many of these people should have been classified as employees all along, however it was not until the passage of AB5 that a clear and concise test was provided to remove the ambiguity of the determination.
Many of you have received questions about classification and pushback from potential or current personnel. This is normal, and we understand! But while the application of AB5 is a relatively recent development, it is not optional, and there are some serious consequences that come with not paying your people in the correct way. So, in this installment of Ask OOTB, we’ll answer some of your most commonly asked questions about misclassification.
Here are the questions we’re going to answer:
What is misclassification?
What are my liabilities if I misclassify a worker?
My artist's tax advisor is stating that they do not have to go on payroll. How should I respond?
Is there any sort of indemnity contract that I can have an independent contractor sign to legally limit my liability?
What’s the worst that can happen if I misclassify one of my workers?
But first, of course, some housekeeping:
Ask OOTB is an ongoing series in which we share some of the most commonly asked questions that we receive, along with relevant information that can help you better understand all things payroll. If you have a question that you would like us to tackle, please submit it to us via our Ask OOTB online form.
And an important note: The information provided in this article does not, and is not intended to, constitute legal, tax, or financial advice. All information, content, and materials available in this article are for general informational purposes only. Information in this article may not constitute the most up-to-date legal or other information. We highly recommend that you seek the advice of an attorney or tax professional rather than relying solely on the information provided herein.
Question #1: What is misclassification?
We took this straight from the California Department of Industrial Relations website. We couldn’t put it better ourselves, so here it is:
“Misclassification of workers occurs when an employer improperly classifies their employees as independent contractors so that they do not have to pay payroll taxes, minimum wage or overtime, or comply with other wage and hour law requirements such as providing meal periods and rest breaks. Misclassification, or labeling a worker as an independent contractor when they should be an employee, undermines businesses who play by the rules and basic worker protections like minimum wage, paid sick days, and the safety of workplaces. Additionally, the misclassified worker has no workers’ compensation coverage if injured on the job, no right to family leave, no unemployment insurance, no legal right to organize or join a union, and no protection against employer retaliation. This is a form of fraud.”
Question #2: What are my liabilities if I misclassify a worker?
This depends on how your misclassification is brought to the attention of the government or justice system. Here are two common ways you can get into trouble for misclassifying a worker:
Potential audits from government entities:
The IRS conducts audits on behalf of the federal government and the Employment Development Department (EDD) conducts audits for the state of California. The tax consequences of misclassification include:
liability for income and employment taxes that should have been withheld
unpaid workers’ compensation premiums
significant penalties and interest
Wage and hour lawsuits:
If a worker files a lawsuit for misclassification, the results can be devastating. The worker could claim that they should have been classified as an employee and been provided with meal breaks, rest breaks, overtime, sick leave, reimbursements for expenses, pay stubs, etc. Courts will assess damages for:
each and every missed break
unpaid overtime wages
missed or inaccurate pay stubs
Plaintiff attorneys will often bring these cases as a class action, which could cause damages to balloon. The cost to settle and the cost to defend these claims are often in the six- and seven-figure range. Employment practices insurance generally will not cover wage and hour claims without the purchase of special coverages. Called “riders,” these special coverages are typically prohibitively expensive.
Question #3: My artist's tax advisor is stating that they do not have to go on payroll. How should I respond?
It is the responsibility of the employer, not the worker, to determine classification. Workers can not waive their rights or make a voluntary election in regards to classification. In addition, tax advisors are NOT employment lawyers, and can be held professionally liable for providing misleading information to their clients on employment law matters.
In these situations, educate the employee on the fact that a tax or accounting professional is not qualified to provide legal advice in general and lacks the specialized knowledge related to employment law in California. It is important for hiring entities to remember that they maintain ALL liability, cost, penalty, and negative consequences from misclassification. The worker will not suffer any negative impact from being misclassified and paid as an independent contractor (apart from the negative consequences that are inherent to being a misclassified independent contractor, such as a lack of workers’ compensation coverage or unemployment insurance). The hiring entity alone dictates how to pay a worker, and alone maintains the consequences of that decision.
Question #4: If an independent contractor absolutely refuses to go on payroll, but I need them for my shoot to be successful, is there any sort of indemnity contract that I can have them sign to legally limit my liability? If I am willing to take the risk, is this better than nothing?
No. The terms of a contract do not dictate the classification of a worker.
Any contract releasing the rights of a worker regarding their classification would be null and void in court. The worker may willfully enter into a contract as an independent contractor and could still bring a claim if, at any time in the future, they decide they should have been an employee of the hiring entity. Even if that person maintained a desire to be classified as an independent contractor, a class action suit brought by another worker could incorporate other plaintiffs and challenge the validity of their classification.
Question #5: What’s the worst that can happen if I misclassify one of my workers?
To answer this question, we talked to Sarah Léger, Esq. of Ragghianti | Freitas LLP, who provided us with this vivid scenario:
A production company hires an individual to work on a shoot. The day rate for this worker is $800, and they work ten hours on the one-day shoot. This worker takes a lunch break after six hours of work and does not stop for rest breaks. The production company pays this worker as an independent contractor.
The damages that the production company faces for the one-day shoot are:
Wages/overtime: Under CA law, a day rate can only cover 8 hours, so the “hourly rate” is $100 per hour. For the two hours of overtime, the worker is owed $300 (@ OT rate of $150/hr).
Waiting time penalties: For the failure to pay the worker the OT owed at the end of the shoot, waiting penalties accrue at a rate of $1,100 per day (average daily rate) for up to 30 days they are unpaid, for a total of $33,000.
Meal/rest penalties: For the failure to take rest breaks, the worker is owed $100. For the failure to take a timely lunch break, the worker is owed $100.
Misclassification: For the misclassification, Labor Code 226.8 provides for penalties in the amount of $5,000 to $15,000 for a first time violation of misclassification. For a pattern of misclassification, the penalties rise to $10,000 to $25,000.
Thus, for a one-day shoot for one worker, the misclassification could cost anywhere from $38,400 to $58,500, plus penalties, fees, and interest from the IRS for the failure to withhold.
Finally, this also opens up a potential for representative action (via PAGA claim or class action), which could easily and rapidly multiply these damages.
After reading this installment of Ask OOTB, we hope you have a better understanding of who is legally responsible for misclassification and the scale of the liabilities that come with it. The facts speak for themselves. Educate yourself, learn the rules, follow them, and if you need help, ask OOTB!
Sources:
Assembly Bill 5 Text:
California Legislative Information. (2019, September 19). AB-5 Worker status: employees and independent contractors. https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201920200AB5
What is Misclassification?:
California Department of Industrial Relations. (2019, December). Misclassification. https://www.dir.ca.gov/fraud_prevention/Misclassification.htm