California Passes Tough Independent Contractor Law

On October 9, 2011, Governor Brown signed into law Senate Bill 459 regarding independent contractors. The law significantly increases the risks and penalties for misclassifying workers as independent contractors by imposing significant penalties on employers found to have engaged in a misclassification, as well as on non-lawyer advisors (like accountants) who advise an employer to engage in such treatment.

The Governor’s signature comes just days after the IRS announced its new Voluntary Classification Settlement Program (VCSP). The VCSP provides generous forgiveness of most of the amounts that would otherwise be due at the federal level for those employers that reclassify independent contractors as employees. As we warned at the time, acceptance of the VCSP might be a trap because it could make defense of non-IRS actions almost impossible. However, if the classification of workers as independent contractors is not well-founded, the new California law provides still another reason to make changes.

In some industries, use of independent contractors is widespread, but not easily justified. The fact that (i) others in the industry are doing the same thing, or (ii) it saves money, will not be useful defenses. Instead, employers treating workers as independent contractors should go through the detailed factual analysis of the common law tests of what constitutes an independent contractor vs. an employee. If litigation is required, the presentation can usually be improved with a testifying accountant who can both (i) present the business’s situation, and (ii) draw comparisons to other economic situations that provide important insights as to the correct answer.

Although the California Labor Commissioner is charged with enforcement of this new law, individuals may file their own complaints judicially. As a practical matter, by creating a private right of action with enormous penalties, class action litigation presents a much greater threat than government enforcement. We review these significant penalties and when they are applicable in this article.

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