Classifying Employees: Independent Contractors Or Exempt

If there is a ground zero of potential liability, this is it.  Cash-strapped federal regulators and states are focusing on misclassification cases with renewed zeal and enthusiasm. And companies, even with the best of intentions, often mischaracterize employees as independent contractors (consultants or advisers). Independent contractors are not subject to wage and hour laws, meaning they don’t need to be paid minimum wage or overtime, are not subject to payroll taxes, and are not entitled to meal and rest periods. Some companies use the “try and buy” approach of hiring a “contractor” for a few months before “converting” him or her to a full-time employee. But companies and contractors are not free to decide what type of relationship they are creating. Federal and state laws alone dictate what constitutes an employee versus an independent contractor relationship.

Some states, like California, have a multi-factor test to distinguish independent contractors from employees, including whether the worker provides his or her own supplies and instruments, whether the worker renders services on the company’s premises, what type of services are being rendered, the permanence of the working relationship, whether the parties believe that they were entering into an employer-employee relationship, and many other factors. Note that having a written contract or consulting agreement is not dispositive.

The mischaracterization of independent contractors who are actually employees usually results in the nonpayment of wages to which the individual would otherwise have been entitled, unpaid payroll taxes with interest and multiple penalties for nonpayment of wages. Companies should ensure that their workers are in fact properly classified as independent contractors and seek guidance from legal counsel when uncertain. Another common mistake is misclassifying employees. For instance, California law separates employees into “exempt” and “nonexempt” categories. The most common exempt categories are executive, administrative, professional, outside sales, commissioned employee and computer professional. While the categories appear similar to federal law, their minimum salary requirements and exempt duties are distinct.

Another common mistake is misclassifying employees. California law separates employees into “exempt” and “nonexempt” categories. The most common exempt categories are executive, administrative, professional, outside sales, commissioned employee and computer professional. While the categories appear similar to federal law, their minimum salary requirements and exempt duties are distinct.

If you think this is an obscure and relatively unimportant administrative detail, think again. This single largest source of class action liability has plagued California employers during the past decade, and the exposure can be breathtaking. Worse, a job description doesn’t provide an adequate defense if the actual job responsibilities have evolved over time, so “fixing” the problem once won’t guarantee that it won’t happen again.

Vigilance is the only sure defense. Companies should regularly monitor the exempt status of their employees. When undertaking an audit of exempt status, payroll practices or pay differentials, companies should use counsel to establish and maintain the privileged nature of the audit and its results. Failing to do so could make the audit discoverable should litigation ensue and the results could be potentially disastrous.