EDD WORKER STATUS: Employee vs Independent Contractor WHAT YOU NEED TO KNOW
Without question, the EDD’s scrutiny of small businesses is on the rise. Audits are increasing. The EDD is honing its focus and its audit activities toward the improper treatment and classification of workers as independent contractors instead of employees. For troubled businesses in today’s difficult and uncertain economic climate, it is very tempting to save money by not withholding and paying over proper employment taxes to both the EDD and IRS. Payroll taxes are expensive. Not paying them over several quarters or even several years adds up to a substantial amount of money indeed. I have often been told by clients under audit by the EDD for employment tax violations that if they did withhold they would not be competitive in their industry and most likely would not have economically survived. Unfortunately, this is not an excuse that the EDD will accept!
There is another side to the decision on not withholding and paying over employment taxes. What if an “employer” honestly believes the worker to be an independent contractor? A person in this position may be advised by his tax expert that if he improperly treats a contractor as an employee, and mistakenly pays employment taxes, he will have to go through a difficult and protracted administrative refund process with the EDD that may go to expensive court litigation and also involve him in a time consuming and expensive EDD audit. Talk about being caught between a rock and a hard place!
Knowing how and when to properly a legally classify a worker as an independent contractor can be a huge savings and very significant in today’s economy. To this end, these series of articles will give you the rules and guidelines of how to both avoid the pitfalls of improper classification and at the same time give you the information you need to properly classify a worker. We will also look at examples from various industries on how to make peace with the EDD in classifying workers.
So, how do you find out legally who is an employee? Where do you go to look for the correct answers to this complex and perplexing riddle?
Employee vs. Independent Contractor: Where Does the Search Begin?
The question of employee vs. independent contractor is first and foremost a legal question. What does the law say about who is and who is not an employee? In California, this law is contained in the California Unemployment Insurance Code (CUIC) “The Code”. Official interpretations of these codified laws are contained in official EDD regulations. These regulations are referred to as California Code of Regulations, Title 22.
Let’s start with the Code. The definition of an employee is set forth in CUIC Sections 621(a), (b), and 13004. Section 621(a) and (b) state:
“(a) Any officer of a corporation.
(b) Any individual who, under the usual common law rules applicable in determining the employer-employee relationship has the status of an employee.”
The definition set forth in Section 621(b) is not much help. CUIC Sec. 13004 does not really give us any more information. It states that an “employee” means a resident or a non-resident individual who receives remuneration for services performed within this state including an officer of a corporation.
California Code of Regulations, Title 22, Section 4304-1 – The Key Regulation
The two sections of the code we discussed above sound like, “a rose is a rose is a rose”; not very informative. Therefore, we must go to the next step and look at the regulations under Title 22 of the official regulations. The key is section 4304-1. This section provides the definition of an employee and sets forth the rules generally applicable to determinations of employee status. Section 4304-1 states, “Whether an individual is an employee for the purposes of Sections 621(b) and 13020 of the code will be determined by the usual common law rules applicable in determining an employer-employee relationship” (Section 13020 deals with the mechanics of withholding and contains no definitions). Well, the regulation at first seems to be repeating the language of Section 621(b). It looks like we are about to go around in circles – but wait. Section 4304-1 goes on to give us a strong clue to solving the mystery. It tells us that the most important factor in determining the difference between an employee and an independent contractor is the right of the principal (employer) to control the manner and means of accomplishing the desired result. The right to control does not have to be exercised, it just has to exist.
Regulation Section 4304-1 goes on to list 10 guidelines or factors used by the EDD to determine whether the right to control exists. Let’s look at them.
1. Is the person performing the services engaged in a separately established occupation or business?
2. Is this the type of work that requires supervision?
3. Does the person providing the services have his or her own tools or equipment?
4. How long will the job take to do? The shorter the time, the more likely the worker is an independent contractor.
5. What is the skill level required for the work (a fruit picker vs. a CPA)?
6. What is the method of payment? Per piece produced or by the job?
7. Is the worker’s job a part of the regular business of the principal?
8. How do the parties regard their relationship – employee or independent contractor? Is their a written contract?
9. What is the extent of the actual control by the principal over the worker?
10. Is the principal hiring the worker to work at a business establishment or is this a casual private one time hiring? For example, is the worker hired to regularly clean the windows on my store front vs. hiring the worker to clean the windows at my house after a dry dusty summer?
Regulation 4304 is a very extensive regulation indeed. The regulation goes on to discuss control factors used in 11 industries including the real estate, home health care, product demonstrators, barbering and cosmetology industries. It is well worth your while to consult this regulation should you happen to be in one of these 11 industries.
Both CUIC Section 621(b) and regulation 4304-1 mention “. . . the usual common law rules applicable . . .” In the next installment in this series, we will examine these common law factors used by the EDD to determine workers’ status. We will also review the major California cases that are always cited by administrative law judges in reaching a decision on whether a worker is an employee or independent contractor. The EDD uses more factors than the IRS’s famous “20 factor test” and may not use those factors the same way as the IRS uses them.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure”, both published by Commerce Clearing House.