Business owners beware. On April 30, 2018 the California Supreme Court handed down a ruling that makes it more difficult for businesses to classify certain workers as independent contractors. The decision, Dynamex Operations West, Inc. v. Superior Court, holds that businesses treating workers as independent contractors must be subject to a three part test. If any part of the three part test is failed, then the contractors are to be treated as employees. The so called ABC test is composed of the following:
- The worker is free from the control and direction of the employer in connection with the performance of the work, both under the contract for the performance of such work and in fact;
- 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 the work performed for the hiring entity.
The genesis of this ruling was a lawsuit filed by delivery drivers that were re-classified from employees to independent contractors by Dynamex in 2004. These drivers were classified as employees prior to 2004. In 2004, Dynamex decided to re-classify their positions to independent contractors and the employees filed suit in 2005 arguing that they were performing the same responsibilities as when they were treated as employees and that the reclassification violated California law. As you can see from the above dates, the wheels of justice grind slowly in the Golden State.
While many observers argued that these classifications were unfair to the worker as they did not allow for contractors to receive certain benefits that employees regularly receive, you can be sure that there is a lot more at stake than that. A joint study by Harvard and Princeton economists in 2016 estimated that 12.5 million workers were classified as independent contractors. That amounts to 8.4% of the workforce in the United States. And the California Labor Commissioner estimates that those numbers translate to $7 billion annually in lost payroll taxes for California alone. Couple that with the growth of the gig economy (Uber/Lyft) and the prevalence of contractors as a result, and it is safe to say that this ruling will provide a whole new focus for our taxing agencies.
In the ruling, the court did provide some examples of the above tests. A retail store hiring an outside plumber to repair a leak in a bathroom on its premises or hiring an outside electrician to install a new electrical line, the services of the plumber or electrician are not part of the store’s usual course of business and the store would not reasonably be seen as having suffered or permitted the plumber or electrician to provide services to it as an employee.
On the other side of the coin, a clothing manufacturing company hiring work-at-home seamstresses to make dresses from cloth and patterns supplied by the company that are then sold by the company, or a bakery hiring cake decorators to work on a regular basis on its custom-designed cakes, the workers are part of the employers usual business operation it would be reasonable to view these workers as employees.
Business owners would be wise to consult with their legal counsel and consider reviewing the status of their contractors and applying the above test to determine if their status should be changed to that of employees. Making that reclassification will likely increase costs and that has to be weighed in light of the exposure of penalties and fines if it is discovered that the employees are in fact incorrectly classified. As with everything in life, there are trade-offs and risks.