California Supreme Court Makes It Harder to Call Your Worker a “Freelancer”

It seems like you can’t talk business at all these days without hearing something about the “gig economy.”  For those unfamiliar with the term, the gig economy is a combination of two factors. It’s an environment where many people have a ‘side gig’ to make ends meet, and organizations not wanting to commit to employees, contract with independent workers on a short-term basis.
This situation can actually be a win-win. American workers are able to start a small business on the side, make more money per hour, take better tax write-offs and companies save on employment taxes…a perfect world right?  Well apparently the State of California doesn’t think so.
The most famous examples of gig economy companies, of course, are the ride-sharing companies Uber and Lyft.  But did you know that if you are over age 21 and have a valid driver’s license, you can be your own boss by delivering packages for Amazon through something called Amazon Flex?  And don’t forget about the thousands (maybe millions) of people who make a living selling arts & crafts on Etsy, provide a handyman service or landscaping on the weekend, or sell their skills on websites like Upwork.
According to most estimates, about one in three members of the American workforce (that’s about 55 million people!) work in the gig economy, and that number is expected to grow to roughly 40% of American workers by 2020.
However, then comes California and other State government agencies to the party. One of the biggest issues in the gig economy is the classification of workers.  Essentially, the question is whether an Uber driver (or someone like him/her) should be treated as a W-2 employee (for whom the employer needs to complete additional paperwork, withhold taxes, and deal with things like SUTA, FUTA, FICA, and Workers’ Compensation), or as a 1099 independent contractor (for whom the employer’s responsibilities largely end after cutting them a check).
In Mark Kohler’s article “The difference between sub-contractors and employees”  he explains that “There are facts and circumstances most commonly used to determine the difference between an employee and sub-contractor. It’s a subjective analysis and some facts may indicate that a ‘worker’ is an employee, while other factors indicate that the worker is actually a sub-contractor.”
The bottom line is that in most situations, the more control a company has over how, when and where workers complete their tasks, the more likely those workers are going to be considered employees – regardless of what the parties say in their written agreement.
However, the contours of the law in this area are constantly changing, and judges and legislatures (especially in larger, bluer states) are in most cases making it harder and harder each year to classify workers as independent contractors.  This is almost always politically expedient, given that employee status is typically considered more advantageous than contractor status, and more voters are workers than employers.
A huge recent example of this shift is the unanimous April 30th decision of the California Supreme Court in the case of Dynamex Operations West, Inc. v. Superior Court.  In that case, the court abandoned the typical “control-based” test traditionally used in these types of cases, and instituted a new “ABC Test.”  Under the ABC Test, a worker is properly considered an independent contractor only if the company hiring the worker establishes all of the following:
A) The worker is free from the control and direction of the hiring company in connection with the performance of the work, both under the contract for the performance of the work and in fact;
B) The worker performs work that is outside the usual course of the hiring company’s business; and
C) 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.
All of the above must be met in order for the worker to be considered an independent contractor.
So, let’s think about this in terms of an Uber driver.  Uber can probably make an effective argument that their drivers are free from Uber’s control and direction – so let’s go ahead and assume that Part A of the test is met.  Ok – on to Part B.  What is Uber’s business?  Providing rides to people who need them.  What do Uber drivers do for Uber?  Provide rides to people who need them.  Therefore, is the work performed by Uber drivers “outside the usual course of the hiring company’s business”?  Umm, nope.  This means Uber drivers fail Part B of the ABC Test (they probably fail Part C as well), and are not considered independent contractors in California.  Your move Uber…what’s your plan?  Sorry.
Now, keep in mind that the Dynamex decision only applies in California, and even in California it’s unclear whether the ABC Test applies outside the context of wage law.  However, California is often on the vanguard of these types of changes in the law (not always – sometimes it’s an outlier).  As such, the ABC Test may be coming soon to a state near you!
Also, remember that the ‘sub-contractor’ classification could also be a major problem in other areas.  See this related article “7 Deadly Outcomes of Treating Your Employee as a Sub-Contractor”.
So, what are the takeaways if you have (or are thinking about having) workers who you want to classify as independent contractors?

  1. Find out the law in your state.  It likely won’t be cut and dried (Texas, for example, looks at 20 different factors), but you can get a good sense of which side of the fence you are on by doing some research and speaking with an employment attorney.
  2. Know the consequences of misclassification.  If it’s a close call, then you need to know the risks you would be taking by classifying a worker as an independent contractor instead of as an employee.  This article does an excellent job of exploring the perils of getting this wrong.
  3. Keep the ABC Test in mind.  If you feel like you’re good under your state’s current law, it’s still a good idea to analyze your situation under the ABC Test.  That way, if it becomes the law of the land where you operate, you know where you stand.
  4. Look at your business model.  Would your business be able to survive if you had to classify your workers as employees instead of contractors?  If the answer is no (and especially if the employee/contractor question is a close call), then what steps can you take to change that answer?

The reality is that the practice of trying to call an employee a sub-contractor can be a very dangerous practice and the IRS continues to crack down on small business owners. Now we have States doing the same thing, and all government agencies consistently warn taxpayers that if they are caught paying ‘employees’ as ‘sub-contractors’, they will pay stiff penalties on top of the taxes and interest owing for payroll withholdings that should have taken place.