In recent years, California and federal agencies have highly scrutinized independent contractor status.  While that scrutiny may be abating somewhat on the federal level, it is still alive and well in our golden state.  In fact, the issue has been popping up quite a bit lately in the context of audits by the Employment Development Department (EDD).

One issue that trips up many employers involves a standard provision many companies include in their independent contractor agreements to protect their intellectual property rights.  The standard language involves a statement that any work product developed by the contractor is deemed a “work made for hire“ under the meaning of the US Copyright Act, and is therefore owned exclusively by the company.  In lay terms that means that the company retains the intellectual property rights to works developed under contract.

Unfortunately, under California Unemployment Insurance Code Section 686, that language also means that the contractor is presumed to be an employee.  Yes, that’s right.  Even if the contractor meets none of the common law factors of an employee (i.e. works independently, the company doesn’t control how they do the work, they are paid by project, etc.), and wants or even requests to be a contractor, California’s EDD requires that the contractor be deemed an employee for purposes of unemployment and state disability taxes.

When and if the company is audited, the EDD will ask for copies of all independent contractor agreements, and if those four words are in there, “work made for hire,” the EDD will find the contractor (or group of contractors) should be taxed as employees.  That translates into back taxes, penalties and interest, as well as the potential of a pretty unhelpful precedent for related legal claims.

There is a possible work-around for this language — to use very specific assignment language instead; although this could have serious copyright implications under the “termination of transfer” provisions of the Copyright Act, so please consult a copyright lawyer before going forward with such a work-around.  Companies can also be proactive and remind departing contractors that they are not entitled to unemployment, which might dissuade a contractor from inadvertently triggering an audit.

For companies that rely on independent contractors, including consulting and entertainment businesses, it is especially important to review your contractor agreements for those four “work made for hire” words.  Oh, and if you use independent contractors and don’t have a signed contractor agreement on file, well you have much more risk than just an EDD audit on this one four-word technicality!