Paying all the fringe benefits necessary to hire a W-2 employee is a heavy burden for many small business owners. And while it is the law, many small business owners will intentionally misclassify workers as 1099s to avoid those payroll taxes, unemployment insurance and worker's compensation costs associated with hiring a W-2 employee.
Sometimes, a company will unintentionally misclassify a 1099 worker through a misunderstanding of the new criteria or a chance in the contractors' status that the hirer doesn't know about (like a lapse of a business license). It is in these cases that an experienced advocate can change the outcome of an EDD investigation or audit.
CA EDD has a mandate...
"At the EDD, we are dedicated to detecting, deterring, and preventing any occurrence of fraud in these programs. We use a variety of cutting-edge methods to detect fraudulent activity. We pursue cases involving the fraudulent receipt of benefit payments or evasion of payroll tax reporting obligations and prosecute those responsible to the fullest extent of the law." from the CA EDD website.
Since AB-5 and the Gig work bill passed into law CA EDD is actively looking for violators of the new criteria for 1099 classification.
So What's the Difference?
An employee is in the immediate control of their employer, time, money and method of execution of their job are all dictated by the employer. They are paid a salary and benefits and the employer pays taxes on their behalf.
An independent contractor is their own independent entity with an EIN, Corporate Entity, Web and social presence, and other clients for whom they perform similar services to those they perform for the hirer. 1099's as we often refer to Independent Contractors, pay their own taxes and they are not eligible for unemployment insurance.
Here's an overview of the classification for 10999 contractors vs employees:
- Control: The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work.
- Scope of Work: The worker performs tasks that are outside of the usual course of the hiring entity's business.
- Independence of Entity: The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity.
Penalties for Misclassification Can Be Steep and Swift:
- EDD and the Federal Government can require employers to pay all of the employee's unpaid social security, unemployment, and income tax withholdings. Employers may also be assessed a penalty of $5,000 per misclassified worker plus 1.5% of the employee’s federal income tax liability plus 20% of the amount that should have been withheld for the employee’s social security taxes.
- State tax penalties Failure to pay state tax penalties is a misdemeanor that carries a penalty of $1,000 and up to a year in prison.
- If you don't keep records you can be penalized steeply (ignorance is NOT bliss when it comes to EDD)
What You Can Do If You're Unsure
A tax lawyer can help tell the full narrative of your business, your decisions, choices you have made for other 1099 contractors and other background information to CA EDD. At Milikowsky Tax Law, we are EDD experts with years of experience. We can reach out to auditors who respect us and advocate for you in the event of an EDD audit or investigation. Reach out to us today at (858) 450-1040