If you’re a freelancer, consultant, sole proprietor or any kind of independent contractor, it’s important to understand the different laws that apply. When you are working as an independent contractor for another individual or business – rather than as an employee – there are special tax and legal considerations that you need to be aware of. If you’re a business owner operating in California, things get even more specific. In addition to having to meet the general criteria for being an independent contractor, there are laws in place that specifically govern the relationship between contractors and client businesses operating within the state. Failure to understand and follow these laws can lead to serious financial consequences down the road. To help you avoid such pitfalls, we’ve compiled a brief guide outlining what you need to know about Independent Contractor Law: What You Need To Know (And How To Avoid Mistakes)
California Independent Contractor Law: Know the Difference Between What Defines an Employee vs. an Independent Contractor
When it comes to hiring employees or independent contractors, understanding the legal difference between the two is your first step. When a business hires employees, it assumes legal responsibility for them, including providing them with benefits such as a retirement plan, paid time off and health insurance. Employers are also responsible for adhering to federal and state employment laws such as minimum wage and overtime regulations.
Why is Knowing the Difference Between Employees and Independent Contractors Important?
There are several reasons why it’s critical to understand the difference between employees and independent contractors. To begin with, many businesses make the mistake of classifying their contractors as employees. This can lead to problems. An employee who has been misclassified could file a lawsuit against your company for benefits they weren’t entitled to. If your company is audited by the IRS, the Department of Labor or other government agencies, you risk severe penalties for misclassification. Businesses that misclassify employees as contractors run the risk of losing their employees, as those employees could sue the company so they can be reclassified as employees. Workers who are misclassified as contractors aren’t protected by things like minimum wage, overtime and other regulations that protect employees.
What Are the Requirements to Be a California Independent Contractor?
Under California law, three main criteria must be met in order to qualify as a California independent contractor (also known as the "ABC Test".) 1. Your relationship with the client is “outside the usual course of business” of the client. 2. You have the right to control when, where and how the work is done. 3. You are engaged in an independent trade or occupation for which you could, if necessary, be hired to do the same type of work for other clients.
It’s important to note that there is no one-size-fits-all definition of what an independent contractor is. The term is defined by the type of work that’s being performed, and laws governing the relationship between contractors and their clients vary from state to state. California is one of five states that follow “common law” when classifying contractors. This means that the state uses a “multifactor’ test that analyzes several different aspects of the relationship between contractor and client to determine if an individual should be considered an independent contractor or employee.
Things You Should Know About Being a California Independent Contractor
You Have No Obligation to Report Your Income. If you’re operating as an independent contractor and file your taxes, you do not have to report your income to the Internal Revenue Service (IRS). You also have no obligation to pay any taxes on the income you’re making as a contractor. If you are operating as an employee, on the other hand, you are obligated to report your income and pay taxes on the amount received.
You Need to Provide Your Own Health Insurance. One significant difference between being an employee and independent contractor is that contractors are responsible for their own health insurance and other benefits. This means that, if you’re working as an independent contractor, you are responsible for providing your own health insurance and other benefits that employees are often provided by their companies.
You May Not Be Eligible for Unemployment Insurance. When you’re an employee, you’re automatically eligible for unemployment insurance. If you’re an independent contractor, however, you are not eligible for unemployment insurance and may have difficulty getting workman’s compensation or disability insurance.
You Are Responsible for Managing Your Own Taxes. If you’re an independent contractor, you are responsible for managing your taxes. This means that you have to keep track of all the income you earn and make sure that you’re keeping track of the right deductions and tax credits.
Bottom line
It’s important to understand the difference between being an employee and an independent contractor. The difference between the two lies in the level of control you have over your work and how you’re compensated for it. If you’re an employee, you’re expected to follow the company’s rules and regulations, and be available when needed. If you’re an independent contractor, you can set your own hours and be selective about the projects you take on. Having a basic understanding of the difference between employees and independent contractors can help you navigate legal and tax issues related to your work as a contractor.
What if You're a Business Owner With Independent Contractors, but Don't Meet the Criteria of the ABC Test?
If this is the case, you may think you can get away with it, but that likely will not be the case. California wants their tax money. Independent Contractors have been a factor in why the state of California has NOT gotten their tax dollars back, so there is a significant effort to seek out those businesses at risk of misclassification, which will result in a significant fine in addition to correcting the issue.
The fitness industry is particularly at higher risk, as most instructors, trainers and gym staff have been independent contractors in the past. This article discusses, and how recently passed and proposed employment laws relating to the classification of employees may significantly impact the fitness industry.
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