Are Your Workers ‘Employees’ or ‘Independent Contractors?’
In 2018, the California Supreme Court issued a decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles in which a new standard – commonly referred to as the “ABC Test” – will be used to determine whether a worker is an employee or an independent contractor in California. The ruling of this court has effectively been codified by the state legislature and extends the ABC Test to all provisions and claims based upon the Labor Code and Unemployment Insurance Code of California. On July 1, 2020, this test also will apply to the California Workers Compensation Code.
At present, the ABC Test is used by the U.S. Department of Labor and 33 states. Those states include Alabama, Connecticut, Colorado, Delaware, Georgia, Hawaii, Illinois, Idaho, Indiana, Louisiana, Maryland, Massachusetts, Mississippi, Nebraska, Nevada, New Hampshire, New Jersey, Ohio, Pennsylvania, Vermont, Washington and West Virginia.
The test is not exactly the same in all states. In some states, working within a company’s premises may make it more likely that a worker will be classified as an employee. You are advised to check with an employment law attorney in your state to be sure that you meet the test applicable to your state.
What is the ABC Test in California? The test presumptively considers all workers to be employees and forces a business hiring an individual to bear the burden of proving each of the following three conditions if the worker is to be properly classified as an independent contractor:
1. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under contract for the performance of the work and in fact.
2. The worker performs work outside the usual course of the hiring entity’s business.
3. The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.
Although the state legislature has established some exemptions, most employers will be covered by the law. A previously existing test will continue to apply to certain exceptions.
Ultimately, workers in California claiming misclassification as independent contractors can and will use this ABC Test to make claims that they are employees and are entitled to make claims such as failure to reimburse necessary business expenses, failure to provide accurate and complete wage statements, failure to pay unemployment insurance tax, and failure to provide workers’ compensation insurance.
In view of the ABC Test, characterizing a laundromat attendant – who opens and closes a store at your direction, cleans the store at your direction, and does not work for others – as an independent contractor will prove to be a laughable event at any of the various state and federal agencies required to assess penalties against you.
An individual who serves as a “cleanup” person a few times a day at your store or a repair person who may not have other customers raises issues of control and direction. However, if the worker has an independently established trade or business under which the work performed for you is also performed at other businesses, a better argument can be made that the individual is an independent contractor.
Does the worker in fact have other customers? Does the worker have a business license, a copy of which has been provided to you for confirmation? Does the worker use his or her own tools and perhaps operate out of a vehicle with signage evidencing an independently establish trade?
A worker conducting wash-dry-fold activity at your laundromat and who retains the revenue from that portion of the business is, in my opinion, likely to be considered an employee, rather than an independent contractor.
First of all, the worker appears to perform work within the usual course of your business and, thus, fails the second of the three ABC Tests.
Secondly, retaining the revenue or compensation is not the issue. The real issue is control. Is this worker required to be present at the business for a substantial number of hours each day? Does the worker conduct this business solely for you? Does the worker use your washers and dryers?
The decision to classify workers as employees or independent contractors is a decision that has crucial tax consequences. In recent years, the Internal Revenue Service and state employment tax agencies have undertaken substantial audit activity to determine whether employers have improperly characterized employees as independent contractors for the purpose of avoiding the payment of Social Security, Medicare and unemployment taxes, as well as the withholding of income, Social Security and state disability taxes on wages that are actually or constructively paid to an employee.
Even the unintentional misclassification of a worker as an independent contractor rather than an employee will cause the imposition of substantial financial liability on the part of the employer. In addition to being liable for the employer’s portion of employment taxes, which would have been payable if the employer had correctly classified the worker as an employee, the employer also will likely be required to pay the amount of income and other payroll taxes that should have been withheld from employee compensation for the past three years. Intentional misclassification also will result in the imposition of substantial penalties.
Your misguided determination as to employee or independent contractor status will not be binding upon the Internal Revenue Service or your state employment tax agency.
The amount of control an employer exercises over a worker has historically been the focus of the Internal Revenue Service in determining whether the worker is an independent contractor or employee. The IRS presently focuses on three categories: (1) behavioral control, (2) financial control and (3) relationship of the parties. The IRS has issued a statement under Topic No. 762 to assist in determining independent contractor or employee status and can easily be found on the internet.
The category of behavioral control is intended to cover “facts that show if the business has the right to direct and control what work is accomplished and how the work is done, through instruction, training, or other means.”
The concept of financial control is intended to cover “facts that show if the business has the right to direct and control the financial and business aspect of the worker’s job, including whether the worker has unreimbursed business expenses, the worker’s investment in facilities or tools in performing the work, the extent to which the worker makes his or her services available to the market, how the business pays the worker and the extent the worker can realize a profit or incur a loss.”
The concept of relationship of the parties is intended to cover “facts that show the type of relationship the parties had. This includes: written contracts… whether the business provides that worker with employees’ benefits… the permanency of the relationship, and the extent to which services performed by the worker are a key aspect of the regular business of the company.”
If you incorrectly characterize your attendant as an independent contractor, paying no heed to the payroll tax requirement, and the day comes when you elect to terminate the attendant’s services, you may thus be faced with both a claim for unemployment compensation and audits by the IRS and, in California, the Employment Development Department. You also may face a claim for workers’ compensation, if this worker dropped a washer motor on his foot shortly before his departure.
It’s not unusual to see a laundromat owner hire a worker on Monday morning at 9 a.m. and terminate that same individual by noon for unsatisfactory performance. Treating the worker as an independent contractor – without regard to payroll tax deductions – may seem to be momentarily expedient, but it will not seem so when the attendant files a claim for unemployment compensation that very afternoon.
If you conduct your laundry business through a corporation, the government will reach through the so-called “corporate shield” as though it were made of cotton candy. If the corporation is without sufficient funds to respond, the government will move to collect the taxes from any “responsible person” related to the employer. For example, officers of the corporation, particularly those with any control over funds, are generally considered “responsible persons” and subject to such tax liability, regardless of their ownership interest in the corporation.
The moral of the story? If you treat your workers as employees, the Internal Revenue Service and your state employment tax agency will have nothing to complain about. If you do otherwise, you may find yourself with a business headache for which there is no inexpensive over-the-counter remedy.
[This column is intended to provide general information only. It is not intended to provide specific legal advice. If you have a question regarding the law, be sure to contact your business attorney.]