This post discusses why – especially now that Assembly Bill No. 5 (AB-5) has taken effect – in California corporate officers are considered employees rather than independent contractors.
California Corporate Officers Employees by Statute
The starting point is California Unemployment Insurance Code Section 621. This Section states, in relevant part:
“Employee” means all of the following:
(a) Any officer of a corporation.
In the past, one reasonably could argue that Section 621 does not apply to the extent that an individual is providing services that are outside the scope of his or her responsibilities as an officer.
For example, a corporate secretary is responsible for maintaining corporate records. If that individual also is leading development of the company’s software product, then one reasonably could consider such work to be the services of an independent contractor.
Effect of Assembly Bill No. 5
But AB-5 has obliterated that argument. That legislation is reflected in several statutes, including Unemployment Insurance Code Section 621 referenced above. In particular, Subsection (b) states that a worker can be an independent contractor only if:
(2) The individual performs work that is outside the usual course of the hiring entity’s business.
Naturally, the individual will be doing work that is within the usual course of the corporation’s business. As a result, California will consider that individual an employee even while performing non-officer duties!
Incentive to Misclassify and Associated Risks
Of course, there are strong financial incentives for a small corporation to misclassify employees as independent contractors:
- There is no need to pay personnel the applicable minimum wage. (Founders often are willing to accept unpaid “sweat equity” in their startups.)
- There is no need to make unemployment or social security contributions, or incur the overhead of withholding taxes.
- There is no need to provide vacation time.
So, what are the risks if a company misclassifies a California corporate officer as an independent contractor? If a state or federal governmental entity learns about the misclassification, the company may have to pay all of the amounts described above, plus interest and penalties.
Furthermore, California Labor Code Section 226.8 provides that willful (i.e., voluntary and knowing) misclassification of employees as independent contractors can result in:
- Civil penalties of $5,000-15,000 per violation.
- If there is a pattern or practice of such misclassification, civil penalties of $10,000-25,000 per violation.
- An obligation to display to the public and to employees a notice acknowledging the violation and providing information for employee reporting of suspected misclassification.
I expect that, nevertheless, many startup and early stage companies in California will continue to misclassify their officers, either knowingly or unknowingly. And so long as relations among founders remain harmonious, there will be no incentive to bring such misclassification to the attention of any governmental authority.
- Required Officers – California Corporations are Unique
- Corporate Officers in California Need to Be More Careful than Directors
Dana H. Shultz, Attorney at Law +1 510-547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.