Misclassification

What Is Misclassification?

Misclassification occurs when a business improperly categorizes a worker's employment status, denying them legal protections and benefits they are entitled to receive. In California, misclassification takes two primary forms:

1. Employee vs. Independent Contractor Misclassification: Treating workers who are legally employees as independent contractors

2. Exempt vs. Non-Exempt Misclassification: Treating non-exempt employees as exempt employees to avoid overtime and break requirements

Both forms of misclassification deprive workers of significant protections under California law and expose businesses to substantial legal and financial liability.

The Scope of Misclassification in California

Misclassification is widespread, particularly in certain industries:

Industries with High Misclassification Rates

Industry	Common Misclassification Issues
Construction	Subcontractor misclassification
Transportation/Delivery	Drivers classified as contractors
Gig Economy	App-based workers
Healthcare	Home care workers, nurses
Janitorial	Cleaning workers
Trucking	Owner-operators and company drivers
Tech	"Freelance" developers working full-time
Entertainment	Production workers
Hospitality	Hotel and restaurant workers
Agriculture	Farmworkers and harvesters

Economic Impact

Stakeholder	Impact of Misclassification
Workers	Lost wages, benefits, and protections
Legitimate businesses	Unfair competition from non-compliant competitors
State of California	Lost tax revenue (estimated billions annually)
Social programs	Underfunded unemployment and workers' comp

Types of Misclassification

Type 1: Employee to Independent Contractor

This occurs when a business treats workers who meet the legal definition of employees as independent contractors to avoid:

Avoided Obligation	Impact on Worker
Minimum wage	May earn below minimum wage
Overtime	No premium pay for long hours
Meal breaks	No guaranteed break time
Rest breaks	No paid rest periods
Workers' compensation	No coverage for workplace injuries
Unemployment insurance	No safety net if work ends
Payroll taxes	Worker bears full tax burden
Expense reimbursement	Out-of-pocket business expenses
Anti-discrimination protections	Limited legal recourse

California's ABC Test

Under the ABC test, a worker is an employee unless the hiring entity proves ALL three conditions:

• A: Worker is free from control and direction
• B: Work is outside the usual course of business
• C: Worker has an independently established business

Failure on ANY prong means the worker is an employee.

Type 2: Non-Exempt to Exempt

This occurs when employers classify workers as exempt employees who don't actually qualify, avoiding:

Avoided Obligation	Impact on Worker
Daily overtime	No pay for hours over 8
Weekly overtime	No pay for hours over 40
Double time	No 2× pay for long days
Meal break penalties	No compensation for missed breaks
Rest break penalties	No compensation for missed breaks
Accurate time records	No tracking of hours worked

Requirements for Exempt Status

To be properly classified as exempt, employees must meet:

1. Salary threshold: At least 2× state minimum wage annually ($68,640 in 2025)
2. Duties test: Primarily (>50%) perform exempt duties
3. Salary basis: Paid fixed salary regardless of hours

Common Misclassification Scenarios

Scenario 1: The "Independent" Driver

Situation: A delivery company classifies all drivers as independent contractors. Drivers wear company uniforms, drive company-branded vehicles, follow company routes, and work set schedules.

Analysis:

• Prong A: Company controls schedule, routes, methods - FAILS
• Prong B: Delivery is the company's core business - FAILS
• Prong C: Drivers have no other clients or business presence - FAILS

Result: Misclassification. Drivers are employees.

Scenario 2: The "Freelance" Tech Worker

Situation: A software company engages a "freelance" developer who works 40+ hours weekly, on-site, using company equipment, on an ongoing basis with no other clients.

Analysis:

• Prong A: Company controls when, where, and how work is done - FAILS
• Prong B: Software development is the company's business - FAILS
• Prong C: Worker has no independent business, only one client - FAILS

Result: Misclassification. Developer is an employee.

Scenario 3: The "Exempt" Assistant Manager

Situation: A retail store pays an "Assistant Manager" a $50,000 salary with no overtime. The worker spends 80% of time on sales floor helping customers and stocking shelves.

Analysis:

• Salary test: Below $68,640 threshold - FAILS
• Duties test: Only 20% management work, not >50% - FAILS

Result: Misclassification. Worker is non-exempt, owed overtime.

Scenario 4: The Converted Employee

Situation: A company lays off employees, then rehires them as "consultants" doing the same work, at the same location, under the same supervision.

Analysis: Same work + same relationship = same classification. Title change doesn't change legal status.

Result: Misclassification. Workers remain employees.

Identifying Misclassification

Red Flags for Employee/Contractor Misclassification

Red Flag	Why It Indicates Misclassification
Required schedule	Independent contractors set own hours
Company equipment	Contractors provide own tools
Company email address	Indicates integration into business
Required on-site work	Contractors choose work location
Single client	True contractors have multiple clients
Indefinite engagement	Contractors have project-based work
Same work as employees	If employees do it, so should worker
Required training	Contractors already have expertise
Performance reviews	Employment-style oversight

Red Flags for Exempt/Non-Exempt Misclassification

Red Flag	Why It Indicates Misclassification
Below salary threshold	Must meet 2× minimum wage test
Mostly production work	Must primarily do exempt duties
Hourly tracking with no OT	If tracking hours, likely non-exempt
No management authority	Executive exemption requires this
Following procedures	Exempt requires independent judgment
Routine tasks	Professional exemption requires specialized knowledge

Legal Consequences of Misclassification

Penalties for Independent Contractor Misclassification

Violation	Penalty
Unpaid wages	All wages owed + interest
Unpaid overtime	Back overtime + liquidated damages
Missed breaks	Premium pay for each violation
Willful misclassification (Labor Code 226.8)	$5,000-$25,000 per violation
Pattern of willful misclassification	$10,000-$25,000 per violation
Required posting	Must post notice of violation
Back payroll taxes	Unpaid amounts + penalties
Workers' comp premiums	Back premiums + penalties
PAGA penalties	$100-$200 per pay period per worker

Penalties for Exempt Misclassification

Violation	Penalty
Unpaid overtime	All overtime owed (up to 3-4 years)
Liquidated damages	Equal to unpaid wages
Meal break premiums	1 hour pay per missed break
Rest break premiums	1 hour pay per missed break
Wage statement penalties	$50-$100 per defective statement
Waiting time penalties	Up to 30 days' wages
Interest	10% per year
PAGA penalties	$100-$200 per pay period
Attorney's fees	If employee prevails

Criminal Penalties

In egregious cases, misclassification can result in criminal prosecution:

Conduct	Potential Consequence
Tax fraud	Criminal tax evasion charges
Workers' comp fraud	Felony charges possible
Wage theft	Criminal misdemeanor or felony

Class and Collective Actions

Misclassification often affects multiple workers similarly, leading to:

Class Action Lawsuits

• Single worker sues on behalf of all similarly situated workers
• Damages multiplied across entire class
• Multi-million dollar settlements common
• High-profile cases in trucking, gig economy, retail

PAGA Representative Actions

California's Private Attorneys General Act allows workers to sue on behalf of the state:

• $100 per employee per pay period (initial violations)
• $200 per employee per pay period (subsequent violations)
• 25% to employee, 75% to state
• No class certification required

How Misclassification Is Discovered

Internal Sources

• Employee complaints to HR
• Manager questions about classifications
• Internal audits
• Whistleblower reports

External Sources

Source	How Discovery Happens
Worker complaints to DLSE	Worker files wage claim
EDD audits	Unemployment or tax audits
IRS audits	Employment tax discrepancies
Workers' comp audits	Insurance verification
Competitor complaints	Industry whistleblowing
Media investigations	Journalistic exposure
Government enforcement initiatives	Targeted industry sweeps

Correcting Misclassification

Step 1: Audit Current Classifications

1. Review all independent contractor relationships
2. Apply ABC test to each engagement
3. Review all exempt classifications
4. Verify salary thresholds and duties tests
5. Document findings

Step 2: Reclassify Workers

For independent contractors who should be employees:

Action	Details
Hire as employee	W-2 status, all benefits and protections
Terminate contract	If work is truly outside business
Restructure relationship	If exemption may apply

For exempt employees who should be non-exempt:

Action	Details
Convert to non-exempt	Track hours, pay overtime
Increase salary	If duties support exemption
Modify duties	If role can legitimately become exempt

Step 3: Address Back Liability

Options for addressing past misclassification:

Approach	Considerations
Voluntary disclosure	May reduce penalties in some cases
Settlement with workers	Resolve claims before litigation
Reserve for liability	Prepare for potential claims
Legal consultation	Assess exposure and strategy

Step 4: Implement Compliance Systems

• Written classification policies
• Regular classification reviews
• Training for hiring managers
• Approval process for contractors
• Ongoing monitoring

Prevention Strategies

For Independent Contractor Classifications

1. Apply ABC test before engaging: Don't assume contractor status
2. Require business documentation: Business license, insurance, other clients
3. Define project scope: Clear deliverables and timeline
4. Avoid control: Don't dictate how, when, or where
5. Use written contracts: Clearly define relationship
6. Review regularly: Relationships evolve; reclassify when needed

For Exempt Classifications

1. Verify salary threshold: Must meet current 2× minimum wage
2. Analyze actual duties: What do they really spend time on?
3. Document duties test: Written analysis supporting exemption
4. Review annually: When duties or laws change
5. Track borderline positions: Extra scrutiny for close calls
6. When in doubt, non-exempt: Safer to provide protections

Enforcement Trends

California has increased misclassification enforcement through:

• Task Force on the Underground Economy: Multi-agency enforcement
• AB5 implementation: Stronger contractor rules
• PAGA expansion: More private enforcement
• Industry-specific enforcement: Trucking, construction, gig economy focus
• Increased penalties: Higher fines for willful violations

Resources

For Employers

• Consult employment law attorney before classifying workers
• California DLSE guidance on employee status
• IRS guidance on employment taxes

For Workers

• California Labor Commissioner complaint process
• Legal aid organizations
• Private employment attorneys (often contingency-based)