Determining if a worker qualifies as an employee or independent contractor can sometimes be a difficult thing to do and deciding incorrectly can have a punitive effect on your business.
As a business owner classifying someone as an independent contractor can work out to be cheaper for you in the short term since you do not have to pay any employer taxes or benefits and the only cost to you is the amount the contractor bills for their service. On the other hand, if that same person were to be classified as an employee, you would be responsible for the employer portion of payroll taxes, workers comp insurance, and medical benefits (depending on the size of your company). If you were to mistakenly, or purposely, classify someone as an independent contractor, you would be responsible for paying back taxes and can be heavily fined by the IRS and CA EDD. As a rule of thumb, most people consult the IRS 20 factor test which the IRS uses to determine if someone should be classified as an employee. The 20 questions fall into three categories; behavioral, financial, and type of relationship. The test is trying to determine the right of control or degree of control that the employer/business has over the worker (see links for more detail on what each of the categories test). California has a similar test (essentially 11 factors) and they start from the presumption that the person is an employee and then work back from there.
Now, because of a California court ruling on April 30, 2018, the previous tests could, at least for businesses in California, be thrown out the window and replaced with a 3-factor test. The court ruling was specific to interpreting California’s Industrial Welfare Commission’s wage orders, but this could expand out to all independent contractor relationships in California. The new “ABC” test established in the Dynamex Operations West, Inc. v. Superior Court of Los Angeles, No. S222732 (Cal. Sup. Ct. Apr. 30, 2018) is as follows:
(A) that the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;
(B) that the worker performs work that is outside the usual course of the hiring entity’s business; and
(C) that 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.
This new ruling could mean a huge shift is coming, especially in the Bay Area where a lot of “gig economy” employers depend on having workers classified as independent contractors.
To read the full court opinion click here.