U.S. Department of Labor's Wage and Hour Division and State of California recently entered into a new agreement to reduce independent contractor misclassification, aiming to protect the rights of employees and level the playing field for responsible employers by reducing the practice of independent contractor misclassification. California is the 12th state to enter into such an agreement.

“We are standing together with the state of California to end the practice of misclassifying employees," said Nancy J. Leppink, deputy administrator of the U.S Department of Labor’s Wage and Hour Division. "This is an important step toward making sure that the American dream is still available for workers and responsible employers alike."

Employee misclassification is a growing problem. In 2011, the Wage and Hour Division collected more than $5 million in back wages for minimum wage and overtime violations under the Fair Labor Standards Act that resulted from employees being misclassified as independent contractors or otherwise not treated as employees.

The misclassification of employees as something else, such as independent contractors, presents a serious issue, as these employees often are denied access to benefits and protection — such as family and medical leave, overtime compensation, minimum wage pay and Unemployment Insurance — to which they may be entitled.

In addition, misclassification can create economic pressure for law-abiding business owners, who often struggle to compete with those who are skirting the law. Employee misclassification also generates substantial losses for state Unemployment Insurance and workers' compensation funds.

Effective January 2012, California's Labor and Workforce Development Agency was given the power to hand out civil penalties of between $5,000 and $15,000 for each misclassified employee in addition to those civil penalties already permitted by law. The civil penalties increase to $10,000 and $25,000 for each violation if the Agency determines that the employer has engaged in a pattern, or practice, of willful misclassification of its employees as independent contractors.

However, that’s not the end of the financial liability of misclassification. In addition to any fines or penalties assessed by either the IRS or a state agency, the misclassified employee can seek up to three years worth of unpaid wages (including overtime and meal and rest break violations) and penalties for violating the California Labor Code. In addition to this, if the misclassified worker was injured during the time with the company, the business owner could face liability for not securing the proper worker’s compensation insurance.

The line between what constitutes a worker being an independent contractor versus an employee and many companies fall foul of the law accidentally. If you’re unsure if your contractors would be better classified as employees, you can take the IRS 20 point test here or give us a call and ask at 855 250 5000.