Many small business owners are tempted to classify workers as independent contractors rather than employees. They see it as a way to avoid payroll taxes, benefits, overtime pay, and the hassle of tracking hours. However, taking this shortcut can be a costly mistake, especially in California, where employment laws strongly favor workers.
The Risks of Misclassification
Misclassifying an employee as an independent contractor can result in severe penalties, including back wages, unpaid overtime, missed break penalties, tax liabilities, and hefty fines. The California Department of Industrial Relations (DIR) and the Employment Development Department (EDD) aggressively pursue misclassification claims. Additionally, plaintiffs’ employment attorneys, who often work on contingency, are quick to take on cases where violations can be stacked for maximum recovery.
California uses the ABC Test to determine whether a worker is truly an independent contractor. Under this test, a worker is presumed to be an employee unless the hiring entity proves:
- The worker is free from the control and direction of the hiring entity in performing the work.
- The worker performs work that is outside the usual course of the hiring entity’s business.
- The worker is customarily engaged in an independently established trade, occupation, or business.
If a worker does not meet all three of these criteria, they must be classified as an employee.
A Cautionary Tale: A Costly $200,000 Mistake
One California business owner learned the hard way that cutting corners with employee classification can backfire. The employer hired a worker and classified them as an exempt salaried employee under the “administrative” exemption. The employer did not require the employee to track hours and believed they were being generous by paying for 4-6 hours more than the employee actually worked each pay period. However, the salary paid did not meet the minimum double-minimum-wage requirement under California law for an exempt employee.
The worker later retained a plaintiff’s employment attorney and made a claim for $200,000 in unpaid wages, penalties, and damages. Despite the employer’s belief that they had treated the employee fairly, California’s strict wage and hour laws allowed for significant liability due to:
- Failure to pay minimum salary requirements for exemption – Even if an employee meets the duties test for an exemption, they must be paid at least twice the minimum wage for full-time employment.
- Paystub violations – Inaccurate or missing pay stubs resulted in penalties.
- Unpaid wages and overtime – Without proper time records, it became very hard for the employer to prove the actual time the employee worked.
- Missed break penalties – Because the worker was misclassified, they were entitled to rest and meal break compensation and the lack of consistent time records made it, again, very hard for the employer to overcome this claim in this employee-friendly state.
- Waiting time penalties – California imposes fines when final wages are not paid promptly upon termination. Even just one hour’s worth of unpaid work time at California’s current $16.50 minimum wage can theoretically support a waiting time penalty of $3,960.00! (Remember different municipalities and industries in California can have different minimum wage requirements.)
- The employer’s failure to properly classify and document hours worked left them vulnerable to an expensive lawsuit.
How to Protect Your Business
- Review the California Industrial Welfare Commission (IWC) Wage Orders – The IWC wage orders outline specific employee classifications, minimum wages, overtime rules, and exemptions. Employers can access these orders through the California Department of Industrial Relations website.
- Ensure Employees Meet Exemption Tests – If you are paying someone on a salary basis, verify that they meet both the duties test and minimum salary requirements. If they don’t, they must be classified as non-exempt and receive overtime pay.
- Keep Accurate Time Records – Even for exempt employees, tracking hours worked can help avoid disputes. Non-exempt employees should always clock in and out to ensure compliance with wage and hour laws.
- Have Employees Confirm Their Hours/Pay – Consider having employees sign-off on the accuracy of the hours they input into their time-sheets. Many employees round up or down, which could unintentionally lead to liability on the part of the employer (even though an employee might be doing it for completely innocent reasons and may think they are doing their employer a favor – they aren’t).
- Issue Compliant Pay Stubs – California has strict requirements for pay stub information. Failing to include necessary details (hours worked, overtime, break periods, etc.) can lead to automatic penalties.
- Consult a Lawyer – Before classifying a worker as an independent contractor or exempt employee, seek legal advice. An employment law attorney can help you navigate California’s complex wage and hour laws to avoid costly mistakes.
Final Thoughts
Many business owners think that misclassifying employees or paying salaries without tracking time is a way to simplify operations. However, in California, such shortcuts can lead to devastating financial consequences. Employers must take the time to understand labor laws and ensure proper classification, or they may find themselves facing lawsuits that could threaten their business’s survival.
If you have questions about worker classification or wage compliance, contact a small business attorney before it’s too late. Taking the right steps now can save you hundreds of thousands of dollars in legal claims down the road.