What Is the ABC Test for Independent Contractors?
The Dynamex Case and Independent Contractor Status
The IRS and the U.S. states are always looking carefully at the way businesses classify workers – as independent contractors or as employees. Recently, that careful scrutiny has included a new way to test worker status and more narrowly define who is an "independent contractor." It's called the ABC test.
Forbes says that this new test is "being used in some capacity in nearly every state." Any business that hires independent contractors needs to be aware of the implications of this test.
One important thing to remember when you read about employees vs. independent contractors: The IRS and the states assume that a worker is an employee unless proven otherwise.
What Is the ABC Test for Independent Contractors?
The test may be worded differently for various states, so we'll use the California test, as described in a recent (April 18) California Supreme Court case The ruling was for the purpose of wage orders (state wages, hours, and working condition requirements). The "Dynamex Case" illustrates the decision process to determine independent contractor status only for the purpose of wage orders. Remember, this case only affects California, but California is often a leader in these types of cases.
The Court said that the worker could ONLY be an independent contractor if each of these three factors was met:
- The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the 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.
Why the ABC Test Is So Important
Let's look at each of these test factors a little more closely to see how this change affects the way businesses will have to consider classifying workers in the future. Remember that all three tests must be met.
A. The "control and direction" requirement factor for independent contractors is long-standing, and it's the general test that the IRS uses. The IRS looks at three factors of control – behavioral, financial, and relationship control. The IRS also looks at each business on a case-by-case basis. No one factor is considered defining. Even if a contract exists, that's not in itself proof of an independent contractor relationship. Including this factor isn't surprising, and it's basic to the definition of an independent contractor.
B. The "work outside the usual course of the hiring entity's business" factor is a new twist. This concept began with the gig economy businesses like Uber. Even if the control and direction requirement is met, it looks like an Uber driver is doing work that is WITHIN the usual course of business. Uber is about driving people. Uber drivers drive people. Workers outside the core functions of a specific business would include the types of jobs that can be outsourced, such as maintenance companies, financial support functions like payroll and accounting, and technical businesses like IT and call centers.
C. Finally, the "customarily engaged" in an independent business factor further limits the possibility of these workers being independent contractors. The types of workers who would fit into this category would be professionals; particularly licensed ones. They might have their own practices or who work for a variety of customers within the scope of their professional duties. These independent professionals include a wide range of occupations, including barbers, massage therapists, CPA's, freelance artists, chiropractors, and many more. The IRS lists veterinarians, contractors (in construction industries), subcontractors, public stenographers, and others.
Taken together, the ABC test is a much stricter and narrower test, limiting an employer's ability to classify workers as independent contractors.
How Does The ABC Test Affect My Business?
The law is evolving. Although several states have adopted the ABC Test as law, other states may be using it for only specific situations, like determining unemployment insurance eligibility.
Court cases are popping up all over the country. In the case of Uber, courts have taken different stances on this question. A U.S. court judge in Philadelphia said limousine drivers for Uber are independent contractors, But the New York Unemployment Insurance Board ruled that Uber drivers are employees. Both cases used "control and direction" as criteria.
The IRS doesn't use this test explicitly yet. The IRS notes the common law factors that "provide evidence of the degree of control and independence" as behavioral, financial, and relationship type. They also note that the business should look at the entire relationship and document each of the factors.
Which Law Do I Follow? State or Federal?
It's confusing when federal and state laws conflict. Which rules? The general rule, as noted by Lawyers.com, is that you as an employer "must follow whichever law is most generous to employees." That's why the federal and state default status is that of an employee. The burden of proof is on the employer to justify the independent contractor status.
State laws may be limited in scope, as in the case of some states which use this test only for unemployment compensation. Businesses can be audited or reviewed by either federal or state regulators.
So, What Do I Do?
If you think your business might need to re-examine the status of some workers you employ, start by getting an employment law attorney. You will need to look at the current employment laws in your state and have your attorney keep you advised of issues and changes.
If you fail to classify a worker correctly, it could mean fines, penalties, and retroactive payment of wages, or getting a settlement offer. It's worth getting in touch with someone who can help you sort out the muddle.