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Calif. Cracks Down on Independent Contractor Classification


Calif. Cracks Down on Independent Contractor Classification


Employees Concept. Word on Folder Register of Card Index. Selective Focus.California businesses might soon need to overhaul their staff compensation models, thanks to a ruling from the state's Supreme Court that sets a more rigid standard for determining "independent contractor" status.

As detailed here, the ruling puts the onus on employers to prove a worker's independent contractor status by satisfying all three components of a rigid new "ABC" test.

According to the court's decision, this test presumptively considers all workers to be employees, and permits workers to be classified as independent contractors only if the hiring business demonstrates that the worker in question:

  1. 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;
  2. performs work that is outside the usual course of the hiring entity's business; and
  3. is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

What This Means for California Businesses
It's the "B" portion of the ABC test that will most likely alter the landscape of the gig economy. According to The New York Times, that provision is modeled after similar laws in Massachusetts and New Jersey in which a "worker is considered an employee if he or she performs a job that is part of the 'usual course' of the company's business."

As an example, the court said that someone who sews garments for a clothing manufacturer, using material that the manufacturer provides, would be considered an employee, not an independent contractor. That would be the case even if the employee worked at home and set his or her own hours, since the production of clothing is the company's core business.

By contrast, a plumber whom the clothing manufacturer hires to fix a leaky pipe on the premises would be an independent contractor because plumbing work falls outside the scope of the manufacturer's business. (See additional examples here.)

Possible Gray Areas
It's common practice for technology startups to classify and pay their first wave of labor resources as independent contractors to minimize expenses until they raise enough capital to convert their staff to be W-2 employees. (Read "What's the True Cost of a New Employee?" for a primer on the cost of W-2 labor.)

In some cases, such as driver-for-hire services like Uber and Lyft, the California ruling seems clear-cut. Since the whole purpose of such businesses is to provide transportation, the ruling would seem to compel driver-for-hire services to reclassify their drivers as employees rather than independent contractors.

Other situations are more ambiguous. Take bookkeeping, for example. Let's say you run a small business with a heavy cash flow. Once or twice a week, a freelance bookkeeper comes to your place of business to reconcile all of your accounts. You've always regarded the bookkeeper as an independent contractor and paid him or her accordingly. But would California's courts now see that arrangement differently?

Probably. For one thing, the fact that you require the bookkeeper to come to your office and use your office equipment might violate the "A" portion of the ABC test, "that the worker is free from the control and direction of the hirer."

The courts might even rule that the arrangement violates the "B" portion. They might determine that keeping the books in a high-cash-flow business is indeed "a job that is part of the 'usual course' of the company's business," clearly different from the ad hoc nature of a plumber fixing a leaky pipe.

Are There Any Other Options?
So is the only alternative for employers to start hiring more employees? Not necessarily. Outsourcing to a professional services firm could be a viable third option. Take that example of the small business with high cash flow cited above. At first glance, it would appear that the only choice would be to convert the freelance bookkeeper from an independent contractor to a part-time (or even full-time) employee.

But that employer actually has a third option: Switch to an outsourced bookkeeping service. In that instance, the employer would be hiring a company, not an individual. And by definition, a company cannot be an employee.

Problem solved.
Mark Wald


Mark Wald

Mark Wald, Managing Director, Supporting Strategies | Santa Monica, LA, and Ventura County, provides bookkeeping and controller services to growing businesses.

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