Independent Contractor vs. Employee in California

If you are an employer bringing on a new worker, you may want to classify the worker as an independent contractor rather than an employee. The distinction between independent contractors and employees is significant and carries various implications for both the worker and the entity hiring them. For example, employers are generally not required to pay or withhold taxes on payments made to the independent contractor, but are required to do so on employee wages. Independent contractors instead report their income as self-employment income and pay self-employment taxes.

It’s important for employers to carefully consider these differences and assess the specific needs of their business when deciding whether to hire an independent contractor or an employee. Misclassification of workers can have legal and financial consequences, so it’s advisable to consult with legal and tax professionals to ensure compliance with relevant laws and regulations.

How to Classify Workers

There are a few frameworks to consider when classifying workers:

ABC Test

California law has specific requirements for the proper classification of workers as independent contractors or employees. Assembly Bill 5 (“AB5”), which went into effect on January 1, 2020, codified what’s known as the ABC test into California law. The ABC test is used to determine whether a worker is an independent contractor or employee.
Under the ABC test, a worker is presumed to be an employee unless the employer can demonstrate all of the following:

(A) The worker is free from the control and direction of the employer;

(B) The worker performs work that is outside the usual course of the employer’s business; and

(C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Borello Test

Before the ABC test, the Borello test was used to assesses various factors to evaluate the overall nature of the working relationship between the worker and employer. Unlike the ABC test, which is more structured and consists of specific criteria, the Borello test offers greater flexibility by considering a range of factors beyond control. These factors typically include:

Control. The degree of control the employer has over the worker’s workflow is an important factor under the Borello test, but it’s just one of several factors considered.
Special Skills. Whether the work requires special skills or expertise that the worker brings to the job, which may suggest independent contractor status.
Method of Payment. How the worker is compensated, such as by the hour, by the project, or through commission, can provide insight into the nature of the relationship.
Furnishing of Equipment and Materials. Whether the employer provides the tools, equipment, or materials necessary to perform the work.
Opportunity for Profit or Loss. Whether the worker has the opportunity to make a profit or incur a loss based on their own business decisions and investments.
Permanency of the Relationship. The duration and regularity of the working relationship, with more long-term and consistent arrangements often indicative of an employer-employee relationship.
Integration of Services. Whether the worker’s services are integrated into the core business operations of the employer, which may suggest employee status.
Intent of the Parties. The expressed intent of the parties regarding the nature of their relationship, although this factor alone is not determinative.

IRS Categories

The IRS also suggests three categories to consider for worker classification:

Behavioral Control

A worker must be classified as an employee when the employer has the right to control and direct the work that is being performed by the worker. To determine if the employer has behavioral control over the worker, the IRS will consider the following issues:

Types of instructions the employer gives to the worker – instructions may include time frames and locations for work, the type or quality of tools or supplies to be used by the worker, and the location or vendor to use for the purchase of services or supplies.
Character of the instructions given to the worker – less detailed instructions suggest independent contractor status and more detailed instructions suggest employee status.
Oversight of the worker – if the employer is merely concerned with the final product or end result, the worker is more likely an independent contract. But if the employer evaluates the details of how work is completed throughout the process, the worker is more likely an employee.
Training – whether ongoing or periodic, training suggests that a worker is an employee, as independent contractors more typically rely on their own skills and methods.

Financial Control

Another important factor is whether the employer has the right to control and direct the financial aspects of the job being completed by the worker. When conducting the analysis, the IRS may consider:

Expenses – employees are typically reimbursed for all expenses, while independent contractors are likely to have expenses that go unreimbursed.
Equipment – it is more likely that an independent contractor will make a significant financial investment in their own equipment, whereas an employee will typically utilize equipment owned and financed by the employee.
Profit or loss – an independent contractor may have opportunities for loss or profit associated with a particular job.
Open market – employees typically conduct their work for a single employer, while independent contractors often market their services to multiple paying customers or clients.
Payment methods – independent contractors are typically paid a flat fee and may have provided an initial estimate or bid for a project at the outset, while employees are typically paid a guaranteed wage, based on the time they conduct work for the employer.

Relationship of the Parties

Depending on the industry and type of work, the relationship between employers and employees may look very different. Some of the common relevant factors to consider when classifying a worker include:

Contracts – contracts can provide context on the type of relationship the parties intended to create at the outset of relationships, though they are not controlling as to the proper classification of a worker.
Benefits – the employer providing benefits to a worker similar to those normally provided to employees, including vacation and sick pay, pension or retirement plans, and health or life insurance, suggests employee status.
Duration – relationships between employers and employees are typically permanent and ongoing, while relationships between employer and independent contractors are typically limited to a single project or a series of projects.
Key business services – if a worker provides services that are central to the product or service provided by the business (such as a worker assembling cars for a car manufacturer), then it is more likely the worker is an employee. If a worker provides services that are not central to the product or service provided by the business (such as a worker repairing an air conditioning unit in the car manufacturer’s plant), the worker is more likely an independent contractor.

Hiring Independent Contractors vs Employees

Hiring an independent contractor versus an employee involves several key differences, including:

Control – Employers typically have more control over employees compared to independent contractors. Employees are subject to the direction and supervision of the employer, whereas independent contractors have more autonomy in how they perform their work.
Tax and Benefits – Employers are responsible for withholding income taxes, Social Security, and Medicare taxes from employees’ wages, as well as paying unemployment insurance taxes and providing benefits such as health insurance, retirement plans, and paid time off. Independent contractors are responsible for paying their own taxes and providing their own benefits.
Duration and Permanence – Employees are often hired for ongoing, long-term positions, while independent contractors are usually hired for specific projects or a finite period. Employees typically have a more stable and consistent relationship with the employer, while independent contractors may work with multiple clients simultaneously.
Liability – Employers may be liable for the actions of their employees while they are performing job-related duties, whereas independent contractors are generally responsible for their own actions and liabilities.
Cost – Hiring an employee typically involves higher costs for the employer, including wages, benefits, payroll taxes, and potentially additional administrative expenses. Hiring independent contractors may be less expensive in the short term, as employers are not responsible for providing benefits or paying certain taxes.
Training and Supervision – Employers typically provide training and supervision to employees to ensure they perform their duties according to company standards. Independent contractors are expected to possess the necessary skills and expertise to complete the job without extensive training or supervision.
Flexibility – Hiring independent contractors offers employers greater flexibility in scaling their workforce up or down based on project needs. Employees may require more stability and consistency in their work schedules and employment arrangements

1099 Contractors vs Employees

The term “1099” refers to a series of tax forms used to report various types of income received by individuals, independent contractors, freelancers, and other non-employees in the United States. The most common form in this series is the Form 1099-MISC (Miscellaneous Income), which is used to report payments made to non-employees, such as independent contractors, for services rendered.

When a business or individual pays a non-employee $600 or more for services performed during a tax year, they are required to report those payments to the IRS using Form 1099-MISC. This form includes information such as the recipient’s name, address, taxpayer identification number (usually their Social Security number or employer identification number), and the total amount paid during the year.

In addition to Form 1099-MISC, there are other variations of the 1099 series used to report different types of income, such as interest, dividends, retirement distributions, and cancellation of debt. Each form in the 1099 series serves as a record of income earned by the recipient and is used for tax reporting purposes.

1099 tax forms and employee tax forms serve different purposes and are used to report different types of income. Here are some key differences:

Recipient Type:
- 1099 Forms: Typically issued to individuals or entities who are not considered employees, such as independent contractors, freelancers, or businesses providing services to another entity.
- Employee Tax Forms: Used to report wages, salaries, and other compensation paid to individuals who are considered employees of a business or organization.
Income Reported:
- 1099 Forms: Used to report various types of non-employee income, such as payments for services, interest, dividends, rents, royalties, and other miscellaneous income.
- Employee Tax Forms: Primarily used to report wages, salaries, bonuses, tips, and other forms of compensation received as an employee.
Tax Withholding:
- 1099 Forms: Generally, no taxes are withheld from payments reported on Form 1099. Recipients of 1099 income are responsible for reporting and paying their own taxes on this income.
- Employee Tax Forms: Employers are required to withhold federal income tax, Social Security tax, and Medicare tax from employee wages and remit these taxes to the IRS on behalf of the employee.
Employment Relationship:
- 1099 Forms: Typically issued to individuals or entities with whom the payer has a contractual or business relationship, but who are not considered employees of the payer.
- Employee Tax Forms: Used to report income paid to individuals who are employees of the payer. Employees typically work under the direction and control of the employer and are subject to various labor laws and protections.
Form Types:
- 1099 Forms: There are various types of 1099 forms used to report different types of income, such as Form 1099-MISC for miscellaneous income, Form 1099-INT for interest income, and Form 1099-DIV for dividend income.
- Employee Tax Forms: The primary form used to report employee wages and taxes withheld is Form W-2 (Wage and Tax Statement). This form is issued to employees by their employers at the end of the tax year.

In summary, while both 1099 forms and employee tax forms are used to report income to the IRS, they serve different purposes and apply to different types of workers and income sources. It’s important for businesses and individuals to understand these distinctions to ensure accurate tax reporting and compliance with IRS regulations.

Contact Vaksman Khalfin Today

Our team at Vaksman Khalfin, PC can help you with proper worker classification in California. The consequences of worker misclassification are costly, but can be avoided by working with an experienced employment attorney. We can guide you through complex questions and defend your classifications should they be challenged by the IRS or other government entity. Contact us today for a free consultation.