Do you know about the consequences of incorrectly classifying workers?
Employee or Independent Contractor? In a recent opinion, a California appeal court upheld a lower court's ruling, that a group of drivers was incorrectly classified as independent contractors when they were in fact employees. This improper classification cost the employer a substantial monetary penalty. Therefore, taking the time to properly classify the status of a service provider is crucial and necessary to avoid huge tax consequences and other costly repercussions.

Air Couriers Int'l v. Employment Development Dept.: A group of courier companies, called Sonic, employed drivers to deliver packages for businesses. The drivers were classified as independent contractors and were made to sign independent contractor agreements. Sonic also issued them IRS 1099 forms reflecting their annual compensation. Although the drivers were required to have their own vehicles and insurance, they made no other major investments in equipment or materials. The drivers were encouraged to wear Sonic uniforms, were provided with Sonic badges and vehicle badges, and made deliveries to Sonic customers only.

The California Employment Development Department (EDD) assessed Sonic for $617,328, plus interest, based on Sonic's failure to withhold taxes and make unemployment tax contributions. The assessment included a 10% penalty, as authorized by the Unemployment Insurance Code. Sonic paid the fine but then sued the EDD for a refund, arguing that the assessment was in error because the drivers were independent contractors.

What the court said: The extent to which the employer has the right to control the details of a worker's service is the key measure of whether someone is an employee or an independent contractor. The greater the right to control, the more likely the person is an employee. In this case, there was substantial evidence that Sonic controlled the drivers' work. Sonic controlled the workers' breaks, regular schedules, daily routes, and attire. Further, many of the workers had been with Sonic for a substantial amount of time. All of these factors helped support the conclusion of employee status.

Consequences of erroneously classifying workers as independent contractors: Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay taxes on payments to independent contractors. If you incorrectly classify an employee as an independent contractor, however, you can be liable for employment taxes for that employee plus a penalty and interest. If you have mis-classified an entire department or category of workers, the costs multiply quickly.

What you can do:
• Carefully analyze the degree of control you have over a person's work before treating the person as an independent contractor.
• If you want the IRS to determine whether a worker is an employee, file Form SS-8: Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding, with the IRS.

ESKRIDGE LAW may be contacted by phone (310/303-3951), by fax (310/303-3952), or by e-mail (geskridge@eskridgelaw.net.) Please visit our website at www.eskridgelaw.net.

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