What Is the ABC Test for Independent Contractors?
The Dynamex Case and Independent Contractor Status
The ABC test is a guide for employers to use in the determination of if a worker is considered an independent contractor or an employee in the eyes of the government. Several states require the use of the ABC test—in part or in whole—to determine the status of workers. The government's default status of a worker is as an employee unless they can meet specific guidelines. The employer is responsible for the correct categorization of workers or could face costly fines.
Why the Designation Matters
The designation is important because it determines the payment of social security and worker's compensation benefits. Depending on the state where the work is performed, the ABC test may also apply to wages and work hour laws. Some states base the availability of unemployment insurance on the status. Other states will use the test only in specific industries. Be sure to check with your state employment authorities so you stay on the right side of the law.
Another reason the test is important is that many contract positions are frequently lower-paid, service orientated jobs. This feature places an undue hardship on people of color. These jobs include those in landscaping, home health care, house cleaning, janitorial, maintenance, and, security watchmen industries.
States That Use ABC Standards
Most U.S. states use some form of the ABC test to categorize workers. Some—but not all—of the states that use the test include Hawaii, California, Louisiana, Mississippi, Alabama, Pennsylvania, Vermont, New York, Connecticut, Idaho, Colorado, and Illinois.
California saw perhaps one of the most contentious adoptions of the test. The state's Supreme Court ruled in April 2018 on the case of Dynamex Operations West, Inc., v. Superior Court for the classification of employees. The ruling was for the purpose of deciding on state wages, hours controls, 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 ABCs of the ABC Test
As mentioned earlier, states will vary on exactly what parts of the test they apply and when they apply the test to workers. The California ruling found that a 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.
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.
A Closer Look at Test Questions
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. Taken together, the ABC test is a much stricter and narrower test, limiting an employer's ability to classify workers as independent contractors.
The "Control and Direction" Requirement
The use of control and direction is a long-standing measurement for independent contractors. It is 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 control factor is considered defining. Even if a contract exists with the worker, that, in itself, is not proof of an independent contractor relationship. Including this factor isn't surprising, and it's basic to the definition of an independent contractor.
"Work Outside" of Employer's Business Factor
The work outside status is a new twist to classification. This concept began with the gig economy and businesses like Uber. Even if the control and direction requirement of the driver is met, it looks like an Uber driver is doing work that is WITHIN the usual course of Uber's business. Uber is about driving people and 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. Since Uber's business is driving people around, if they hired someone to handle customer service, that would be outside of the usual scope of Uber's business.
"Customarily Engaged in" Independent Contractor Requirement
In California, this requirement further limits the possibility of workers being considered as 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, certified public accountants (CPAs), freelance artists and writers, chiropractors, and many more. The IRS lists veterinarians, construction contractors and subcontractors, public stenographers, and other occupations.
ABC Test and Your Business
The law is evolving. Although several states have adopted the ABC as law, other states may be using it for only specific situations, like determining unemployment insurance eligibility.
However, regardless of how much of the test is applicable in your state, the responsibility falls to the employer and not the worker to check off the boxes. As an employer, you must be able to answer "YES" to all three qualifications to consider a worker an independent contractor. If you answered "No" to any of the questions—including the customarily engaged in question—then the worker is an employee. As such they require a W2, a set work schedule, and the payment of various state and local taxes.
If an employer fails to properly classify a worker they stand to face penalties and monetary fines. They could even face jail time in some cases.
ABC Test and Independent Contractors
If an independent contract worker qualifies as an employee they will need to complete the necessary W4 as an employee. The employer will withhold taxes and contribute payroll taxes to the proper state and federal authorities.
You, as an employee, will be able to claim worker's compensation and unemployment benefits. You will also be eligible to receive your state's minimum hourly wage. Also, you will fall under the state's requirement for overtime.
Confusion abounds between workers and employers. 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.
Following State or Federal Laws
It's confusing when federal and state laws conflict. It leaves employers wondering which rules they should follow. In general, employers should adhere to whichever law is most generous to the worker. That's why the federal and state default status of a worker 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.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.
State of California Dept. of Industrial Relations. "Independent contractor versus employee." Accessed Mar. 10, 2020.