Recent years have seen employers increasingly use "independent contractors" in lieu of employees, believing that these relationships simplify payroll administration, afford the opportunity to "try" a worker before hiring on a "regular" basis, and provide a barrier to employment-related liability. This explosion in independent contractor relationships is especially evident in the dot-com and start-up world, where it is common for a majority of workers to function under some form of alleged independent contractor relationship.

There can be substantial risks associated with these relationships, however. For example, if a company incorrectly characterizes certain workers, it can face IRS fines for failing to withhold payroll taxes, greater liability to third parties for worker conduct and lawsuits by individuals for employment-related claims such as workers' compensation, health and welfare benefits, compensation, breach of contract, discrimination, harassment and wrongful discharge.

It is critical, therefore, to recognize that self-generated labels and written agreements do not bind the courts or the IRS in reviewing whether a worker is an employee or independent contractor. Instead, the IRS and the courts to a lesser and more inconsistent degree will review more than 20 factors to determine an individual's correct status. The bottom line always will be the degree of control the employer has over the way the worker accomplishes relevant tasks or duties. The greater the control over day-to-day activities, the more likely the individual will be characterized as an employee rather than an independent contractor.

Another common trap is the misclassification of an employee as "exempt" (and, thus, not entitled to overtime) under the Fair Labor Standards Act (FLSA) or California's state law equivalent. Most often, particularly with start-ups, every employee is "salaried," no one is being paid overtime, and even the file clerk is someone's "executive assistant." Many employers mistakenly believe that overtime liability can be avoided simply by labeling an employee "salaried" or "exempt." This simply is not the law.

To be exempt from federal and state overtime and minimum wage laws, an employee must satisfy both a duties and salary requirement. The salary requirement that the employee's monthly remuneration be at least $1,993.33 is generally not difficult to satisfy because most "salaried" employees are paid at least this minimum level.

Exempt classifications

It is the duties requirement where most employers fall short. In determining whether an employee satisfies this requirement one must refer to the three recognized exempt classifications of employees professional, executive or administrative and the criteria required to satisfy each. An executive employee is one who, among other things, supervises at least two employees. Very few start-ups have more than a handful of key employees that satisfy the executive test. The administrative exemption essentially requires the employee to exercise independent discretion in fulfilling his or her duties.

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