Employees versus independent contractors
With limited exceptions, workers who perform services for a business are either employees or independent contractors. An independent contractor relationship can benefit both the individual worker and the business.
Workers often enjoy the freedom and flexibility inherent in such a relationship, whereas businesses can often avoid the administrative obligations that come from an employment relationship. Whether a person performing work is considered an employee or an independent contractor, however, is not as simple as the business electing a certain classification. Instead, independent contractor status is determined by application of state and federal laws. Recent changes to those laws have made it increasingly difficult to accurately classify a worker as an independent contractor in California. The risks of misclassifying an employee as an independent contractor are substantial, so it is important that businesses get their classifications correct.
Why Do Employee Versus Independent Contractor Classifications Matter?
Many agencies, both state and federal, scrutinize the independent contractor classifications. All of these agencies have incentive to classify workers as employees rather than independent contractors. The IRS and state taxing agencies want to be sure payroll taxes are collected on all workers who they believe should be classified as employees. State and federal employment agencies, including the Department of Labor, Equal Opportunity Employment Commission, National Labor Relations Board, California Labor Commissioner and California Department of Fair Employment and Housing, all scrutinize the classification to ensure workers who should be classified as employees are receiving the benefits of employee protection laws such as meal and rest breaks, overtime and the right to be free from discrimination and harassment. California’s Employment Development Department will look to ensure that unemployment taxes are withheld for all workers they believe should be employees. And the California Department of Industrial Relations seeks to ensure that employees receive workers’ compensation benefits.
For the above reasons, virtually all of these agencies routinely investigate business classifications. These investigations can result from random audits or, more frequently, after the agency receives a complaint about a specific business. Such complaints often come from a member of the workforce but can be made by just about anyone.
In the event that an agency determines that an independent contractor should have been classified as an employee, the business can be forced to pay taxes that should have been withheld, unpaid wages, penalties and interest. If a misclassified employee files a lawsuit in court, he or she can also recover attorney fees.
The “ABC Test” Used to Determine Independent Contractor Status
Traditionally, each of the agencies used its own independent test to determine how a worker should be classified. While the factors analyzed in each test vary, the most important factor in all tests has traditionally been whether the business has the “right to control the manner and means” in which the work is performed.
However, in 2018, the California Supreme Court issued a ruling in Dynamex Operations West v. Superior Court, which redefined the standard for evaluating whether a worker should be classified as an employee or an independent contractor. Whereas, prior to Dynamex, the right to control the work means and method of performing the work had been the most important factor, under the “ABC Test,” the lack of control is just one of three requirements that a business must meet to properly classify a worker as a contractor. Under the new “ABC Test” set forth in Dynamex, a worker can only be classified as an independent contractor if all of the following elements are met:
- the worker is sufficiently free from the control and direction of the hiring company in connection with the performance of the work;
- the worker performs work that is outside the usual course of the company’s business; and
- the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
To satisfy part A of the ABC Test, the worker must be free from the control and direction of the company, both under the contract and in the actual performance of the work. In an independent contractor relationship, the company’s concern should only be with the result of the work rather than how the result is accomplished. By contrast, if the company exercises the level of control over the worker that it usually exercises over employees, part A is unlikely to be satisfied.
Next, to satisfy part B of the test, it is necessary that the worker not perform the same type of work that the business is primarily engaged in. For restaurants, the usual course of the company’s business is to provide food, drinks and service to customers. This means independent contractors cannot be those directly involved in preparing the food and drinks or providing the service. Cooks, servers, bussers, bartenders and hostesses would therefore not satisfy part B. By contrast, a restaurant may be able to establish an independent contractor relationship with a janitor, accountant or human resources consultant (provided parts A and C are also satisfied), because those workers perform services outside the usual course of the restaurant’s business.
Finally, part C of the ABC test requires that the worker is actively engaged in an independent business performing the work that they have been hired to perform for the company. This can be evidenced by things such as the existence of other clients the worker performs services for, advertising the business, setting up a corporate entity, obtaining licensing and hiring employees. To satisfy part C, it is not sufficient that the company would allow the worker to perform work for other clients. Rather, the worker must independently make the decision to go into business for himself or herself and be actually servicing other clients or at least actively seeking such additional work. By contrast, if the worker performs work only for one restaurant, that worker is unlikely to satisfy part C.
The Dynamex decision had been narrowly construed to apply only to analysis of claims made pursuant to the California Labor Commissioner’s Industrial Wage Orders. Thus, for other types of labor and employment claims, the traditional “control” tests remained in place. However, California recently passed Assembly Bill 5, which codified Dynamex and the ABC Test as the standards for assessing employee/independent contractor status for any issues raised under the California Labor Code or the California Unemployment Insurance Code along with claims raised under the Industrial Welfare Commission Wage Orders. Therefore, with a few narrow exceptions, the ABC Test now governs virtually any inquiry into whether a worker is an employee or a contractor. AB5 is effective as of January 1, 2020. Further, the legislature has determined the ABC Test to be a declaration of existing law, rather than new law or a change to existing law. This means that the ABC Test will apply retroactively even to claims arising out of a working relationship that occurred prior to 2020.
Exceptions to the ABC Test
While AB5 did codify the Dynamex holding, it also carved out various professions as exempt from the ABC Test. These professions include: licensed professionals such as lawyers, architects and engineers; financial services providers such as accountants and insurance brokers; real estate agents; marketing professionals; certain sales persons; human resources administrators; and graphic designers, artists and photographers.
While the above positions are exempt from the ABC Test, it does not automatically mean that a business can classify workers in these professions as independent contractors. Rather, it means that these professions are governed by the prior “control” tests that had been in place before Dynamex and AB5. For example, for these workers, the Borello Test will still govern whether they are employees or contractors for claims brought under the Labor Code. The Borello Test examines the following factors to make that determination:
- whether the one performing services is engaged in a distinct occupation or business;
- the kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;
- the skill required in the particular occupation;
- whether the principal or the worker supplies the instrumentalities, tools, and the place of work for the person doing the work;
- the length of time for which the services are to be performed;
- the method of payment, whether by the time or by the job;
- whether or not the work is a part of the regular business of the principal;
- whether or not the parties believe they are creating the relationship of employer-employee;
- the alleged employee’s opportunity for profit or loss depending on his managerial skill;
- the alleged employee’s investment in equipment or materials required for his task, or his employment of helpers;
- whether the service rendered requires a special skill;
- the degree of permanence of the working relationship; and
- whether the service rendered is an integral part of the alleged employer’s business.
No one factor is determinative under the Borello Test. Rather, courts and agencies examine the totality of the relationship in making a determination.
Risks of Misclassification
In light of the recent changes to the law and increased scrutiny of independent contractor classifications, it is imperative that restaurants examine this issue closely to be sure their classifications are correct. Not only are state and federal agencies auditing businesses for compliance, but they often share their findings with other agencies. For example, the Department of Labor and IRS have a commitment to share findings to “improve department efforts to end the business practice of misclassifying employees in order to avoid providing employment protections.” The DOL also works with various states (including California) to coordinate efforts to investigate and take regulatory action against employers who misclassify their workers.
Employers who misclassify workers will likely be asked to pay back unpaid wages, statutory penalties, UI/SDI contributions, interest on wages/taxes and potential attorney’s fees and costs imposed by various agencies. In addition, liability for these issues can often extend beyond the business and reach individual owners and officers. For example, corporate officers can be personally liable for up to 100 percent of the amount the employer should have withheld from compensation if the IRS can establish willfulness. To protect against that finding, the IRS has implemented a voluntary classification settlement program, which can be located on its website.
There is also potential liability to the misclassified workers themselves, beyond the “back pay” and penalties for missed overtime and meal/rest periods. Misclassified workers can sue to recover the employee benefits they would have received if they were “employees” (health/retirement benefits and expense reimbursements).
Restaurants should audit any existing independent contractor classifications to assess whether the classification is proper in light of AB5. That audit starts by examining whether the worker meets the ABC Test or qualifies as one of the professions that are exempt from the test. For part C, this might mean having the worker verify that he or she does in fact have other clients and/or markets his or her business services, etc. For those workers who are exempt, the business must still examine whether the worker can be classified as an independent contractor under the Borello Test (or a similar “control” test, depending on the nature of the claim). This same analysis should apply to any new relationship the business is contemplating that involves hiring a person to perform work for the company. Restaurants should consult with their legal counsel and human resources professional to the extent they are uncertain whether their independent contractor classification is correct in any given circumstance.
This report was reviewed and updated in 2019 by Weintraub | Tobin. Weintraub | Tobin provides this information for general informational purposes only. The information is not, and should not be relied upon or regarded as, legal advice. No one should act or refrain from acting on the basis of such content or information, without first consulting with and engaging a qualified, licensed attorney, authorized to practice law in such person’s particular jurisdiction, concerning the particular facts and circumstances of the matter at issue.