Hire an independent contractor and comply with California law to avoid triggering an Employment Development Department (EDD) audit.
Following the steps below does not guarantee that your contractor will still remain a contractor if you are audited by EDD. However, there are ways you can strengthen your position and not have your contractors reclassified as employees.
Watch our video below to learn more:
Verify Website and Client Base
Overall, business owners hiring independent contractors should verify that the worker(s) has a website and, more importantly, a client base.
When verifying the website and client base, start with a social media search. The worker’s social media presence can direct you to their website along with informing you on what kind of client base they have.
Both the website and client base are important factors that the government, California EDD, will consider when determining if the worker is a legitimate independent contractor.
Another resource is asking for references from the independent contractor.
Create a Contractor Agreement
When hiring an independent contractor, make sure there is a written contractual agreement. Best practice is to have an attorney create one for you instead of taking a contractual agreement found on the internet. Contracts created by an attorney should not be too expensive.
At a minimum, the contract the attorney creates should:
- State that the hired person is a contractor
- Include that the hiring company doesn’t have control over the worker in terms of behavior, finances, and relationship
The contractor agreement may reference the new law, Assembly Bill 5 (otherwise known as AB-5), that came into effect on January 1st, 2020 in California. The updated bill dictates that independent contractors should be able to determine their own rate, use their own tools, and determine the time they will perform the services.
The ABC test, created under AB-5, provides three criteria all independent contractors must meet in order to be classified as a 1099 independent contractor instead of a W-2 employee.
According to the California Labor and Workforce Development Agency, the three criteria independent contractors must meet under the ABC test are:
- “The worker is free from the control and direction of the hiring entity in connection with the performance of the work, under the contract for the performance of the work.
- The worker performs work that is outside the usual course of the hiring entity’s business.
- The worker is customarily engaged in an independently established trade occupation, or business of the same nature as that involved in the work performed.”
Verify Legitimate EIN Number
When hiring an independent contractor, make sure the worker has a legitimate Employment Identification Number (EIN). This is a Federal Tax Identification number that identifies businesses.
Some workers may not want to have their own registered EIN, but having a hired independent contractor with a current EIN will strengthen your position during an EDD audit. The EIN helps prove they are a registered business.
For example, business owners distributing 1099 forms will have the filing reflect payments from the past year. This form will reference the worker’s EIN number instead of their Social Security Number (SSN). Having an EIN instead of an SSN on the 1099 form will make a difference to the EDD auditing agent to see if they need to open your company up for an audit.
Independent contractors with a corporation or LLC, however, are not required to have an EIN or a business license, but it does help in the face of a potential audit.
Verify Business License
While it may seem like a basic necessity, make sure that your contractor has a legitimate business license. On occasion, workers may have more than one license. If the worker performs various services in different fields, the license number you need would be for the area that the worker is performing services.
Licensed contractors can potentially perform various services in different counties, cities, or states. When they provide a business license, make sure that the license covers the service they are providing in the city or county your company is located.
If you have a subcontractor and you’re going to hire one that’s licensed, and if they’re performing services in a couple of different counties or cities, make sure they have a business license for the area they’re performing services for you, where your company is located.
Business owners can search and verify licenses through the government license search website here.
When hiring and working with independent contractors, collecting invoices from your worker can be easily overlooked. Keep the documentation of the invoices received from the worker and the invoices you distribute as records in case of an EDD audit.
As a reminder, avoid a bi-weekly invoice because it reflects the payment pattern of a W-2 employee. The invoices should reflect payments for the duration of the project the worker was hired for.
Invoices between business owners and independent contractors should detail out information such as:
- Hours worked
- Services provided
- Dates worked
- Payment amount
For instance, an IT company hiring a marketing contractor for a website design should have an invoice that provides the above details for the finished product. If EDD reviews the invoices, the auditor can see that the services provided by the marketing contractor are not similar to the core services the IT company provides.
The two services are unrelated, which satisfies the second element of AB-5 which is: Does the contractor and the company perform different services? In this case, they do. Providing clear proof of the different services your business and a hired independent contractor will help avoid an EDD audit and the fines and penalties associated with misclassification.
Now that you know the important elements needed to properly hire an independent contractor, it would be beneficial to create a hiring checklist tailored specifically to your business and business needs.
Before giving a worker their first check, the W9 should be filled out with the following:
- EIN number
- Business address
- Business license
- Social media accounts
- Website (it could be a Yelp page or a LinkedIn page for smaller businesses)
If the contractor does not have a business website, the LinkedIn page, Yelp account, or whichever page they decided to use should state that they are in business for themselves, are self-employed, and have been for however many years.
Verify your hired independent contractors or future independent contractors with a got1099 report. Our report includes:
- 1099 Business Verification
- EIN Confirmation
- Web and Social media research
- Business entity status
- Tax License Check
- License alerts
- Full staff support
This report helps provide you with the peace of mind that your workers are properly classified. If they aren’t properly classified, we let you know what steps to take to help ensure proper classification.
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got1099 is a business reporting company providing business analysis reports to companies re: their 1099 independent contractors We do not provide legal advice. Consult with your attorney relating to any legal issues.