Last week, the California State Division of Labor Standards Enforcement (DLSE) issued a ruling classifying a driver for popular car service, Uber, as an employee, rather than an independent contractor. While the ruling is, for now, limited to this specific Uber driver, the DLSE’s holding is indicative of a widespread national trend.

While many businesses seek to contain costs – and limit potential employer/employee lawsuits and related liability – by categorizing workers as independent contractors, courts, regulatory agencies and state and federal tax authorities have increasingly ruled against such attempts to do so.

In light of the shifting regulatory environment, businesses should tread carefully when seeking to designate workers as 1099-eligible independent contractors, rather than employees.

When Is a Worker an Independent Contractor?

Independent Contractors Can Be Rewarding

Businesses that are able to classify workers as independent contractors rather than employees are able to take advantage of several legal and tax-related benefits. For example, a business that hires an independent contractor, rather than an employee, would not be required to pay social security or Medicare taxes in connection with that worker’s salary, or state unemployment insurance or workers compensation insurance, or include that worker in the business’s otherwise standard benefits packages. Further, as with Uber (which would be in a position to save money on gas and car maintenance, costs that would otherwise be borne by drivers were they deemed independent contractors), businesses may be able to shunt business-related expenses to the workers, rather than reducing the business’s bottom line.

In addition to the direct financial benefits listed in the preceding paragraph, businesses could limit exposure to potential lawsuits that workers that are classified as employees (but not independent contractors) would otherwise be entitled to bring – including suits based on discrimination, wrongful termination, overtime pay and other similar causes of action.

When Is a Worker an Employee and When an Independent Contractor?

Ascertaining whether or not a worker is an independent contractor vs. an employee is a fact intensive, case-by-case analysis, determined by employing a list of factors cited by state and federal tax authorities and regulatory agencies. The essential factors include: (a) whether or not the business has control (or the right to control) what the worker does and how the worker does his or her job; (b) how compensation/provision of equipment is handled (e.g., how a worker is paid, whether expenses are reimbursed, who provides equipment/supplies, etc.); and (c) whether or not there are written contracts or employee-type benefits, and whether or not the relationship is open-ended, or for a discrete project.

As mentioned above, state and federal agencies are increasingly reluctant to rule that workers are independent contractors – for obvious reasons. For one, the hiring of independent contractors vs. employees reduces the amount of state and federal taxes collected. As a result, it is not uncommon for state and federal agencies to audit businesses that hire independent contractors to confirm compliance with applicable employment laws/classifications. Businesses that are found to have run afoul of those laws could faces stiff penalties, and onerous obligations to pay back taxes for the wrongly classified workers.

Accordingly, it is recommended that you retain qualified legal counsel to ensure that any workers that you intend to hire are properly classified in order to avoid potentially significant liability for you and your business.