As a business owner, you may want to use independent contractors for various work you need to get done. It’s less costly than hiring employees. And during this pandemic period when businesses are trying to recover, the promise of permanent employment may be beyond the ability of owners to make. However, federal and state worker classification laws don’t necessarily leave the decision up to an employer. There’s a maze of these laws and some of these issues have been covered in previous blog posts. But some things have changed, so here’s where things stand now.
Proposed DOL rule
The Fair Labor Standards Act (FLSA) requires minimum wages and overtime compensation to be paid to non-exempt employees; this doesn’t apply to independent contractors because they’re not employees. Under a newly proposed rule, a definition of independent contractor would be adopted for FLSA purposes.
Essentially, independent contractors are workers who, as a matter of economic reality, are in business for themselves as opposed to being economically dependent on the potential employer for work. The nature and degree of the worker’s control over the work and the worker’s opportunity for profit or loss would be indicative of economic dependence (an “economic realities test”).
California and some other states have adopted a special test (“ABC test”) for determining worker classification. Under this test, a worker is treated as an independent contractor only if:
- The worker is free from the control and direction of the hirer in connection with the performance of work, both under the contract for the performance of work and in fact,
- The worker performs work that is outside the usual course of the hiring entity’s business, and
- 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.
As a result of this test, the California Attorney General filed a lawsuit against Uber and Lyft to enjoin them from classifying drivers as independent contractors. In August, a judge granted a preliminary injunction, restraining the companies from defining drivers as contractors rather than employees while a lawsuit on the question proceeds.
The ABC test as enacted in law took effect last year. Now the California legislature has made changes to the ABC test. A bill passed by the Legislature and awaiting the governor’s signature would keep the basic framework of the ABC test but make significant changes in response to various criticism.
California isn’t alone. More than half the states use the ABC test or some part of it. Here’s a map showing which states use which tests in determining worker classification.
Nothing new has happened on the IRS front with respect to worker classification. For purposes of federal wages withholding, FICA taxes, federal unemployment tax, and eligibility for various employee benefits, the IRS has a general rule.
In broad terms, a worker is an independent contractor if the payer has the right to control or direct only the results of the work, and not what will be done and how it will be done. More specifically, the IRS uses a 3-prong test to make this determination:
- Behavioral control
- Financial control
- Relationship of the parties
But IRS rules could change. A bill introduced last year—the New Economy Works to Guarantee Independence and Growth (NEW GIG) Act (S. 700) would create a safe harbor test to classify workers as independent contractors. The measure didn’t get very far, but who knows what could happen in the future?
There is no single definition of an independent contractor that is used by all federal and state purposes. Each department or agency can have separate rules. It’s up to companies to walk a fine line in getting the help they need without becoming entangled with work misclassification claims…by workers or the government.
Best strategy: Work with an employment law attorney to be sure you’re doing things right.