California Increases Risks of Misclassification

On Monday, April 30, the California Supreme Court issued a unanimous 82-page ruling that established a new and more rigorous independent contractor employment standard.

The Dynamex Operations West, Inc. v. Superior Court decision, which sent shockwaves through the “gig” economy, is expected to reverberate nationwide. The more restrictive standard means that firms using independent contractors can no longer engage many of them on the terms they are used to.

New Jersey, for one, reacted immediately. Governor Phil Murphy signed an executive order creating a task force to address worker misclassification. New Jersey also joined 11 other states petitioning the National Labor Relations Board to rule that any intentional decision to misclassify employees as independent contractors violates federal labor laws, as well as applicable state statutes.

Setting a higher standard

The California decision immediately introduced four major changes to the state’s legal standard for distinguishing between employees and independent contractors. The Court:

  1. Replaced the current flexible multi-factor test.
  2. Adopted a rigid, three-prong, “ABC” test, that is currently in use in Massachusetts, Illinois, and New Jersey.
  3. Raised the bar for claiming workers are independent contractors.
  4. Placed the burden of proof on businesses to prove a worker is an independent contractor: workers are now considered employees unless proven otherwise.

 

This ABC test is a seismic change. Businesses now must prove a worker meets all of the following conditions to be an independent contractor; if any condition fails, the worker will be considered an employee:

A. Direction and control. The worker is free from the hiring entity’s control and direction over work performance (e.g., the worker completes the job with no direction, supervision, or set hours);

B. Scope. The worker performs work that is outside the usual course of the hiring entity’s business (e.g., a plumber hired to repair pipes in a retail store); and

C. Independence. The worker is customarily engaged in an independently established trade, occupation, or business.

Because of part B of the test, many businesses view this new standard as the deathblow to using independent contractors: part B expands the definition of employee to cover essentially any worker who contributes directly to the business of the hiring company.

ABC: Not as easy as 1,2,3 for the gig economy

This ruling has immediate and obvious implications for the gig economy, the business model of which is built upon use of independent contractors. However, the stricter independent contractor rules will have implications well beyond companies known for gig work, such as Uber. Freelancers now comprise 35 percent of U.S. workers, according to "Freelancing in America: 2016," a survey by the Freelancers Union and Upwork. Last year’s survey indicated the freelance workforce has grown three times faster than the overall U.S. workforce since 2014, and could represent a majority of workers by 2027.

The top job categories for contractors include computers and IT, followed by administrative, accounting and finance. A 2014 survey by Flexjobs found the top 55 companies relying on freelance workers included Bloomberg, KPMG, and Time Warner Cable.1

Shrinking tax revenues drive change

The increased use of independent contractors has reduced federal and state government revenue, in the form of payroll taxes, unemployment insurance, workers’ compensation premiums and unpaid, uncollectible income taxes. Federal and State agencies are all chasing the lost revenue, with added fines.

These governmental entities are slated to benefit from the Dynamex court decision. In California, the Division of Labor Standards Enforcement inspected more than 2,400 worksites in fiscal 2015-16 and issued citations for 2,100 violations with more than $18 million in penalties.2 California estimates that worker misclassification costs the state $7 billion a year in lost payroll taxes3 – roughly four percent of the current budget.

What it means

Worker misclassification can result in costly damages and penalties. Businesses now need to review their independent contractor engagements against the unambiguous ABC test. They will inevitably have to make some changes, in California and the other states that support it.

Making increasing percentages of personnel a variable cost, combined with the ability to add specialized expertise on demand, has made working with freelancers a compelling proposition for many businesses. Workers too have enjoyed this flexibility, as demonstrated by the rise of the gig economy. Yet arguably there has been a social cost, as both sides have traded more freedom for less security. Staffing companies have provided an interesting middle ground, keeping all the legal boxes checked for both groups, vetting each side for the other, and offering even better flexibility to both, thanks to having a large pool of workers, and another of clients, to match between.

Under the Dynamex ruling the proposition presented by staffing companies becomes even more compelling. When a worker is engaged through, and an employee of, a staffing or consulting firm, there is no longer a misclassification risk, even under the new ruling.

 

 

 

Reynolds, Brie Weiler. 55 Top Companies Hiring for Freelance Jobs, Flexjobs, September 15, 2014.

Department Of Industrial Relations. 2015–2016 Fiscal Year Report On The Effectiveness Of The Bureau Of Field Enforcement, State of California, 2016.

https://www.dir.ca.gov