EDD ABC Test : What to know about EDD Worker Classification Audits

Assembly Bill (AB) 5 and AB 2257 replaced the common law test with the EDD ABC test to determine whether a worker is an employee or independent contractor in California. The EDD will apply the ABC test for the purpose of the Unemployment Insurance Code beginning January 1, 2020. Under the ABC test, the EDD will classify a worker as an employee and not an independent contractor, unless the hiring entity meets all three conditions of the ABC test:

1. The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
2. Performs work that is outside the usual course of the hiring entity’s business.
3. The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

If an employer does not pass all three of the above conditions, then the EDD will reclassify an independent contractor as an employee.

Part A: Is the worker free from the control and direction of the hiring entity in the performance of the work, both under the contract for the performance of the work and in fact?

The California Supreme Court in Dynamex explained prong A as follows:

• A worker who is subject, either as a matter of contractual right or in actual practice, to the type and degree of control a business typically exercises over employees would be considered an employee.
• Depending on the nature of the work and overall arrangement between the parties, a business need not control the precise manner or details of the work in order to be found to have maintained the necessary control that an employer ordinarily possesses over its employees.

The California Supreme Court in Dynamex provided the following examples of how to apply Prong A:

• An employer failed to establish that work-at-home knitters and sewers who made the clothing were sufficiently free from the company’s control where the employer provided the workers with the same patterns. The court reasoned that “[t]he degree of control and direction over the production (…) is no different when the sweater is knitted at home at midnight than if it were produced between nine and five in a factory.” (Fleece on Earth v. Dep’t of Emple. & Training (Vt. 2007) 181 Vt. 458, 923 A.2d 594.)

• A construction company proved that a worker who specialized in historic reconstruction was sufficiently free of the company’s control where the worker set his own schedule, worked without supervision, purchased all materials using his own business credit card, and had declined an offer of employment proffered by the company (Great N. Constr., Inc. v. Dept. of Labor (Vt. 2016) 204 Vt. 1, 161 A.3d 1207).

PART B: Does the worker perform work that is outside the usual course of the hiring entity’s business

The California Supreme Court in Dynamex analyzed Prong B as follows:

• Contracted workers who provide services in a role comparable to that of existing employees will likely be viewed as working in the usual course of the hiring entity’s business.

The California Supreme Court in Dynamex provided the following examples of Prong B being applied:

• Prong B is satisfied (e., services are not part of the hiring entity’s usual course of business):
  • When a retail store hires an outside plumber to repair a leak in a bathroom on its premises.
  • When a retail store hires an outside electrician to install a new electrical line.
• Prong B is not satisfied (e., services are part of the hiring entity’s usual course of business):
  • When a clothing manufacturing company hires work-at-home seamstresses to make dresses from cloth and patterns supplied by the company that will thereafter be sold by the company.
  • When a bakery hires cake decorators to work on a regular basis on its custom-designed cakes.

PART C: Is the worker customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity?

In analyzing Prong C of the ABC test, the California Supreme Court in Dynamex and subsequent appellate court decisions explained:

• The hiring entity must prove the independent business operation is actually in existence at the time the work is performed. The fact that the business operation could come into existence in the future is not sufficient. 
• An individual who independently has made the decision to go into business generally takes the usual steps to establish and promote that independent business.

Examples of this include:

• Incorporation, licensure, advertisements,
• Routine offerings to provide the services of the independent business to the public or to a number of potential customers, and the like.

• Prong C is not necessarily satisfied:
  • Where the hiring entity unilaterally assigns the worker the label “independent contractor.”
  • Where the hiring entity requires the worker, as a condition of hiring, to enter into a contract that designates the worker an independent contractor.

If an individual’s work relies on a single employer. For example, Prong C was not satisfied where a taxi driver was required to hold a municipal permit that may only be used while that driver is employed by a specific taxi company (Garcia v. Border Transportation Group (2018) 28 Cal.App.5th 558, 575).

What are the exceptions to the EDD’s ABC Test?

The EDD ABC Test does not apply to the several occupations as defined in the paragraphs outlined in AB5. Instead, the determination of employee or independent contractor status for individuals in those occupations shall be governed by Borello for the following (among others and a brief summary is listed below):

(a) A person or organization who is licensed by the Department of Insurance who provides underwriting inspections, premium audits, risk management, or loss control work for the insurance and financial service industries.

(b) A physician and surgeon, dentist, podiatrist, psychologist, or veterinarian licensed by the State of California.

(c) An individual who holds an active license from the State of California and is practicing one of the following recognized professions: lawyer, architect, landscape architect, engineer, private investigator, or accountant.

(d) A securities broker-dealer or investment adviser or their agents and representatives.

(e) A direct sales salesperson as described in Section 650 of the Unemployment Insurance Code.

(f) A manufactured housing salesperson..

(g) A commercial fisher working on an American vessel.

AB5 outlines another major exception: a contract for “professional services.” Moreover, this exception has a long list of conditions. Contact a tax attorney to discuss these conditions.

Business to Business contracting Relationship: Another EDD ABC Test Exception

AB5 outlines another exception to the ABC Test: that which applies to a bonafide business to business relationship. Therefore, if a business entity contracts to provide services to another business, the EDD uses Borello to analyze the worker classification. The business must meet 12 conditions.

What is the difference between the ABC Test and the Borrello Test?

Under the EDD interpretation and application of Labor Code provisions, both the Borello test and the ABC test assume that the worker is an employee; the hiring entity must prove that the worker is an independent contractor.

However, the legislature designed the ABC test to make it easier for both businesses and workers to determine in advance whether a worker is an independent contractor or an employee. In other words, the California Legislature aimed at being more predictable than the multifactor approach used under Borello.

Unlike the ABC test — in which the inability of the hiring entity to demonstrate any part of the three-part test means that the worker is not an independent contractor — under the Borello test, no single factor determines whether a worker is an employee or an independent contractor. Moreover, courts consider all potentially relevant factors on a case-by-case basis in light of the nature of the work, the overall arrangement between the parties, and the purpose of the law.

As you can see, there are several exceptions to the ABC test. When the EDD audits a business, the auditor will review the factors in the ABC test to make any adjustments or reclassifications. The ABC test does not govern several categories of occupations; the prior independent contractor classification factors govern those occupations. If you have any questions or have received an EDD audit letter, contact a tax attorney today to discuss how to respond to the EDD.