A common question that taxpayers ask their tax attorney is whether a worker is an independent contractor or employee. In addition, what are the boundaries to that distinction? What are the factors? What if the worker prefers to be an independent contractor, has her or her own business, works for several employers simultaneously, and has almost total flexibility over their work schedule? The EDD is the California state agency that administers employment taxes, conducts audits, and enforces collection activities. And finally, how does AB5 change EDD worker classifications and what impact did it have on EDD audits?
Common Law Test for Worker Classification
The fundamental principles of employee and independent contractor relationships are relatively simple. If a worker is an employee under common law, the business that employs the worker must report the worker’s earnings to the Employment Development Department (EDD) and must pay employment taxes on those wages. In addition, if the worker is an independent contractor and the business pays the worker $600 or more in payments, the business must file a Form 1099-MISC with the Internal Revenue Service (IRS).
Right of Control
The basic test for determining whether a worker is an independent contractor or an employee is whether the employer has the right to control the manner and means by which the work is performed. When the employer has the “right of control,” the worker will be an employee even if the principal never actually exercises the control. Correspondingly, If the principal does not have the right of control, the worker will generally be an independent contractor.
Worker Classification Factors
If, on the face of the relationship, it is not clear whether the principal has the “right of control,” there are secondary factors that are considered to determine the existence or nonexistence of the right of control. Tax attorneys that represent taxpayers before the EDD will be familiar with these factors and have experience in determining which factors are most important. The factors are as follows:
- Do you instruct or supervise the person while he or she is working?
- Can the worker quit or be discharged (fired) at any time?
- Is the work being performed part of your regular business?
- Does the worker have a separately established business?
- Is the worker free to make business decisions which affect his or her ability to profit from the work?
- Does the individual have a substantial investment in their job which would subject him or her to a financial risk of loss?
- Do you have employees who do the same type of work?
- Do you furnish the tools, equipment, or supplies used to perform the work?
- Is the work considered unskilled or semi-skilled labor?
- Do you provide training for the worker?
- Is the worker paid a fixed salary, an hourly wage, or based on a piece rate basis?
- Did the worker previously perform the same or similar services for you as an employee?
- Does the worker believe that he or she is an employee?
As you can see, the factors are numerous and often blur together. In addition, EDD auditors do not always follow any clear guidelines about which factor is most important. Moreover, Sometimes EDD auditors merely hold onto one factor and disregard all other factors. These factors provide a relatively murky test when determining whether a worker is classified correctly. That is perhaps appropriate because worker-employer relationships are complex and do not have a one size fits all standard. In like manner, the multi factored test seems to capture the complexities of worker-employer relationships.
How did AB5 Change Worker Classifications?
Tax attorneys and businesses now have a new regime to work through to determine whether a worker is an independent contractor. Assembly Bill (AB) 5, recently signed into law, replaces the common law test with the ABC test to determine whether a worker is an employee or independent contractor in California. Consequently, You may have asked your tax attorney: how did AB5 change EDD worker classifications? Effective January 1, 2020, hiring entities are required to classify workers as employees unless they meet all conditions of the ABC test:
- The person is free from the control and direction of the hiring entity in connection with the performance of the work. Look at both the contract for the performance of the work and in fact.
- The person performs work that is outside the usual course of the hiring entity’s business.
- The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
As is evident, the factors have been completely revamped. The new ABC test is less fact intensive and much more of a bright line test. According to the CDTFA, After January 1, 2020, workers will be considered employees unless proven otherwise. The CDTFA has placed the burden of proof on employers. Therefore, the hiring entity must show that workers meet all conditions of the ABC test in order to classify them as independent contractors, unless there is a statutory exclusion or determination of employment. AB 5 does not change how out-of-state workers are classified.
Exceptions to AB5 ABC Test
If a court of law rules that the three-part test as outlined above cannot be applied to a particular context, then the determination of employee or independent contractor status in that context shall instead be governed by the California Supreme Court’s decision in S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341 (Borello). As a result, you may need to review case law in some cases to determine the correct worker classification.
AB5 Provides New Worker Classification Rules for EDD Audits
How did AB5 change EDD worker classifications? Tax attorneys and businesses now have a different worker classification regime to apply going forward. Although, the common law factors are generally not applicable going forward, they are still applicable to IRS worker classification audits. If you have questions about EDD worker classifications or your business is experiencing an EDD audit, contact a tax attorney today at Disparte Tax Law.