Correctly classifying workers as employees or independent contractors has always been tricky. Depending on the regulatory agency involved and whether you’re dealing with state or federal law, there are numerous different factors and tests that can apply to your decision.
In April 2018, a ruling by the California Supreme Court added a new test to the mix, and depending on how it plays out in the Golden State, it may have a ripple effect on worker classification laws across the rest of the country.
The ruling was made in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, in which the California Supreme Court adopted what’s known as the ABC Test. Following the Dynamex case, unless California business owners can prove a worker is an independent contractor using the ABC Test, all workers are presumed to be employees.
As a result, the California Supreme Court has dramatically reduced the number of people in the state who are eligible for independent contractor status. And though California is the first big state to make the ABC Test law, the test is already in use in two other states, and more than 20 states apply specific aspects of it in certain circumstances.
Given this, it’s important for employers in all states to understand how the test works and what its impact might be on your business.
The ABC Test
In the California case, delivery drivers who worked for Dynamex, a nationwide courier and delivery service, sued the company for classifying them as independent contractors rather than employees. Prior to 2004, Dynamex classified its California drivers as employees. But in 2004, Dynamex converted all of its drivers to independent contractors to reduce costs.
Using the new ABC Test’s standards, the California Supreme Court ruled in favor of the drivers, noting that Dynamex should have classified them as employees, not independent contractors. As a result, the ABC Test is now law in California, and it stands to affect more than just those in the parcel-delivery business.
The test spells out three new standards, each of which must be met, in order for the independent contractor status to be appropriate. A worker can be classified as an independent contractor only if all of the following three standards are met:
A. The worker is free from control and direction of the employer in connection with the performance of the service, both under contract and in fact;
B. The service is performed outside the usual course of the employer’s business; and
C. The worker is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as the service performed.
If a California business can’t claim “yes” to all three parts, the worker must be classified as a W-2 employee.
What this means for businesses
The B prong is particularly troublesome for companies that rely heavily on independent contractors to deliver and/or provide their core product or service. The Court used the example of a retail clothing store that hires an outside plumber to repair a bathroom leak as an example where the worker could be classified as an independent contractor.
Since selling clothing, not fixing plumbing leaks, is the usual course of the store’s business, the independent contractor status would be applicable.
One the other hand, the Court noted that a clothing store that hired seamstresses to create some of the clothes sold in the store would be employees, since they’re performing work that’s in line with the store’s business. Indeed, this is the prong the Court applied to the Dynamex case, seeing that the delivery services provided by its drivers are the core of Dynamex’s business.
The case has many California business owners scrambling to figure out how to comply with the new law, while keeping their business model and company intact. Companies like Uber and Lyft that rely heavily on contract labor face the prospect of completely overhauling their core operations or reclassifying many workers as employees.
What’s more, there are still several questions that need answering. Most notably is whether or not the ABC Test will be applied retroactively. The California Supreme Court has agreed to address this issue, but no decision has been made yet.
A broader impact
While it remains to be seen how the new law will ultimately play out in California, the ABC Test already exists in other states. Both Massachusetts and New Jersey currently use the ABC Test to determine worker classification, and other states like Maine use the ABC Test for specific situations, such as determining unemployment compensation.
With the gig economy’s heavy reliance on freelance labor, it’s likely that more states will soon follow California's lead to help limit the number of workers who can be classified as independent contractors. Regardless if the ABC Test is already law in your state or may become so soon, you should be extra vigilant in classifying your workers to avoid the potential hefty fines and other penalties for misclassification.
Turn to us for guidance
We can review your worker classification practices and help you take the necessary steps to ensure your company is in compliance with these more stringent standards. Additionally, we can assist you in properly drafting your contracts, so you’re better protected from liability if someone does try to sue your company.
We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Call us today to schedule. Or, schedule online.