How to Protect Your Business From Misclassification of Employees

Classifying your workers as employees or independent contractors is a fact-based process. In other words, your preference is only relevant when you create an employment relationship that actually matches it.

You probably already understand the consequences of misclassification. Your company may face tax penalties for underwithholding. It may need to defend itself from enforcement actions by the State of California for failing to provide workers’ compensation insurance and worker lawsuits for wages and overtime.

A lawyer for employers can develop a plan to protect your business from misclassification, providing substantive defenses against these actions and reducing or eliminating the risk that these consequences will even arise.

Why Your Business Needs a Plan From a Lawyer for Employers Before Hiring Workers

The moment you hire workers, your company must be prepared to comply with labor laws. Misclassifying an employee, even briefly, could result in financial and legal liabilities.
Before getting into the mechanics of your plan, you must first understand the classifications you will use.

Employee vs. Independent Contractor

The most important difference is between employees and independent contractors. California uses a three-part test, called the ABC test, to distinguish between employees and independent contractors. This is a relatively new test, adopted by the California Supreme Court in 2018 and codified in 2019.

The statutory test applies to most employment relationships. The main exception occurs when state or federal law requires a different test.

The ABC test starts by presuming that the worker is an employee. You then look at Parts A, B, and C to determine whether the worker qualifies as an independent contractor or not.

Under Part A of the test, you ask whether the worker is free from your company’s control and direction. Again, the answer to this question is determined by both the intent of the parties and the actual relationship created. If your company calls someone an independent contractor, you must truly create a relationship free of direction and control to implement it.

In fact, one of the most common classification mistakes occurs when companies call workers independent contractors while creating employment relationships where they maintain direction and control. In this situation, treating the workers as independent contractors likely qualifies as a misclassification.

Under Part B of the ABC test, you ask whether the worker performs work outside the course of your company’s business. In other words, to classify someone as an independent contractor, you must show that the worker is free to perform outside work and, in fact, takes that work. If your company is the sole source of work, there is a high likelihood that you serve as their employer.

Finally, when applying Part C of the ABC test, you ask whether the worker is customarily engaged in the same work for outside entities as the work performed for your company. Part C supplements Part B of the test. The fact that a worker takes outside work does not necessarily mean they are a contractor if they, for example, work as a food server at two restaurants.

Instead, you look at whether they have an independent business that provides the same services for multiple entities. The state considers several factors, including whether the worker’s occupation requires licensure and whether the worker has incorporated and advertised their business.

If the worker satisfies all three parts of the ABC test, you can classify them as an independent contractor. Since these elements are highly complex, consider contacting a lawyer for employers to explain how each element applies to your company’s business and workers.

Exempt vs. Non-Exempt Employees

The second important distinction is between employees who are exempt from overtime and those who are non-exempt. Generally, exempt employees are those in executive, professional, and administrative positions who are paid a salary.

However, the position and compensation are not the sole determining factors. For example, computer programmers paid hourly and outside salespeople paid a commission are exempt as professionals.

For this classification, you will need to look at the exemptions granted by the state. If your workers do not fall squarely into one of these exemptions, consult a lawyer for employers to verify that you have decided their overtime classification correctly.

Elements of Your Classification Plan

With all this in mind, your HR department can handle most classifications once you have a plan in place. You will train the members of your department responsible for employee classification so they can correctly classify workers and recognize when a more detailed analysis may be needed.

Determine the Correct Classification Based on the Working Relationship

The plan should set out the steps your department will follow when classifying your most common workers. In this way, you will not need to perform the analysis with each new hire. Instead, the plan will have a classification for each position within the company.

When you create a new employment relationship, your outside lawyer for employers can assist you in classifying the workers correctly.

Undertake Regular Compliance Reviews to Discover If You Have Been Misclassifying Employees

Compliance reviews for state and federal labor laws help in two respects. First, the sooner you discover a misclassification, the easier and cheaper it may be to correct it.

For example, suppose you misclassify workers as exempt from overtime, only to discover later that they were non-exempt. Catching up on a few months of unpaid overtime will be less burdensome than catching up on several years of overtime.

Second, agencies are often less harsh when you discover and self-disclose misclassifications. By self-disclosing, you save the agency the time and effort of investigating your company and bringing an enforcement action. As a result, your lawyer for employers can often negotiate a resolution to the misclassification that avoids some or all of the penalties.

Know What to Do if You Discover an Employee Classification Issue

If your department discovers a problem with a classification, you should have a procedure for reviewing the analysis and developing a response plan. This process should include reviews by HR supervisors, your internal legal department, and outside counsel.

Remember that these are not bright-line tests. Your response will often be the result of an analysis to balance the risks and benefits of reclassifying the workers or continuing with the established classification.

Speak with a Lawyer for Employers to Avoid Worker Misclassification in Your Labor Force

Misclassification can have serious consequences for your business. Developing a plan to avoid and detect classification errors can save your company financially, legally, and reputationally.

Misclassification can lead to serious consequences, but with the right plan, you can protect your business from these risks. Work with an experienced lawyer for employers to develop a comprehensive worker classification strategy that ensures compliance and minimizes potential liabilities. Contact Pearlman, Brown & Wax, LLP today to get started on safeguarding your company.