Employee or Independent Contractor? It Depends on Who's Asking

The most basic question about the employment relationship is whether a worker is, in fact, an employee or an independent contractor. The answer depends on who is asking. The Internal Revenue Service, the United States Department of Labor and the states all may apply different criteria and reach different answers to the same question.

Employee status triggers employer and taxpayer obligations under federal and state laws that do not apply to independent contractors. Independent contractors aren’t covered for minimum wages, overtime, employee benefits and other labor law protections. They usually aren’t eligible for unemployment insurance or workers compensation, and they aren’t covered under anti-discrimination and other protective legislation. Independent contractors must pay their own self-employment tax. Employers that misclassify workers as independent contractors instead of employees can be subject to fines, payment of back employment taxes and even imprisonment.

The answer to the classification question is often obvious. The plumber you hire to repair a leaky faucet is certainly an independent contractor. On the other hand, a manufacturer which hires workers to make clothes at home from cloth and patterns supplied by the company would be well advised to classify those workers as employees, not independent contractors.

Workers can be considered employees under state law, but not under federal law, and several states have applied stricter criteria than does the federal government.

The IRS and a few states apply a traditional agency test, under which an individual is an independent contractor if the paying entity has a right to control or direct only the result of the work, not what will be done and how it will be done. Most states, 33 at last count, apply what has come to be called the ABC test. Under it, a worker is an employee unless all of the criteria are satisfied:

A. The worker is free from the control and direction of the hiring entity in performing the work.

B. The worker performs the work outside the company’s usual course of business.

C. The worker is customarily engaged in an independent trade, occupation or business.

With the rise of the gig economy, drawing a line between employees and independent contractors has become even more fraught. California, which applies the ABC test, was at the forefront of the fight over how Uber and Lyft drivers should be classified. California’s answer, which threatened to upset the business model of these ride-sharing companies, as well as others in the gig economy, fueled a years-long battle in that state and has provoked a reaction at the federal level.

Rulings across the country on the classification of Uber drivers have resulted in diametrically opposed answers to the classification question:

· An advisory opinion in Oregon classified Uber drivers as employees using a six-factor test.[1]

· Applying common law agency rules, a Florida appeals court ruled Uber drivers were independent contractors and not entitled to reemployment assistance.[2]

· Focusing on Uber’s control over its drivers, the Pennsylvania Supreme Court ruled the drivers are employees and therefore eligible for unemployment compensation benefits.[3]

· The National Labor Relations Board advised that Uber drivers are independent contractors, not employees, and therefore barred from organizing.[4]

· A New York appellate court, focusing on employer control, found that Uber drivers were employees and therefore eligible to collect unemployment insurance.[5]

The test case in California, which traditionally applied the ABC test, resulted in the California Supreme Court’s decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles.[6] Dynamex, a same-day courier service, initially classified all of its drivers as employees and thus brought them under the protection of applicable wage and hour laws. In 2004, in order to reduce its costs, Dynamex converted all of its drivers to independent contractors, requiring them to provide their own vehicles, and pay all of their transportation expenses, all applicable taxes and workers’ compensation insurance premiums. Dynamex required the workers to wear the company’s shirts and badges, paid for out of workers’ pockets.

At the same time, the drivers had considerable autonomy. Drivers set their own hours. While some worked exclusively for Dynamex, others also worked for competing carriers.

Two delivery drivers sued Dynamex, alleging that it was illegal for the company to fail to pay overtime, compensate the drivers for business expenses and provide itemized wage statements, all in violation of California’s Labor Code.

The California Supreme Court applied the ABC test to the drivers and found they were employees because Dynamex obtained customers for its deliveries, notifying the drivers where to pick up and deliver the packages, and required them to utilize the company’s tracking and record keeping system. The Court also found it crucial that the work of the drivers was within the usual course of Dyamex’s delivery business.

If all of this were not ominous enough for companies in the gig economy, in 2019, California enacted legislation,[7] effective January 1, 2020, which changed the test for determining whether a California worker is an employee or independent contractor for purposes of the Labor Code, the Unemployment Insurance Code and Wage Orders of the California Industrial Welfare Commission. The law specifically exempted certain workers—for example, licensed insurance agents, licensed health care professionals, registered securities broker-dealers and investment advisors, direct sales salespersons, real estate licensees and construction subcontractors, among others. If workers did not fall within one of the enumerated exemptions, it is unlikely that they could qualify as independent contractors. The law was aimed squarely at ride-sharing and delivery companies.

This is where the United States Department of Labor (“DOL”) stepped into offer its own entry. On September 22, 2020, DOL proposed a rule embodying a new test to determine whether workers are independent contractors or employees under the Fair Labor Standards Act. For the first time, DOL would set its own criteria for independent contractor status included in a federal regulation.

According to DOL, the rule, if adopted, would make it easier to identify which workers are employees covered by minimum wage, overtime and other provisions of the Federal Labor Standards Act and related laws enforced by DOL. The rule lists five test factors:

1. The nature and degree of the worker’s control over his or her work.

2. The workers’ opportunity for profit or loss based on initiative and/or investment.

3. The amount of skill required for the work.

4. The degree of permanence of the working relationship between the worker and the potential employer.

5. Whether the work is part of an integrated unit of production.

DOL described the first two factors as “core factors” that are more indicative of the question of economic dependence and thus would usually carry greater weight than the other factors. If the two core factors suggest the same result, that result would typically prevail. The final three factors were “additional guide posts” in the analysis, to be utilized when one core factor points toward independent contractor status and the other employee status. Other factors might also be considered if they were relevant to the issue economic dependence.

Calling the new standard an “economic reality” test, DOL gave primacy to whether the workers had the opportunity for profit or loss based on their own initiative. In other words, if workers were in business for themselves and had a degree of control over the work, they were independent contractors, not employees. Evidently, the proposal was designed to ensure Uber drivers, and others, would be ineligible for benefits that would have been due them pursuant to the federal wage and hour laws under a more traditional test.

In a news release published with adoption of the rule[8] on January 7, 2021, DOL described the new rule as “streamlining and clarifying the test,” in order to “reduce worker misclassification, reduce litigation, increase efficiency, and increase job satisfaction and flexibility.” More likely, what DOL really intended was a parting gift to companies in the gig economy. The final rule was undoubtedly a response to lobbying by those industries.

During the time the federal rule proposal was subject to public comment, California voters considered, and on Election Day approved, Proposition 22, a ballot measure that allows gig economy companies, which had uniformly ignored the California law designating their workers as employees, to continue treating drivers as independent contractors. The measure was designed by Uber, Lyft and Door Dash, a delivery service, to exempt their drivers from California labor laws.

The federal rule is unlikely to take effect on March 8, 2021, the scheduled implementation date. The incoming Biden administration has characterized the rule as one that makes “it easier for companies…to avoid the minimum wage and overtime protections…costing workers nearly $3.7 billion annually.” [9] If the incoming administration were to “freeze” the rule, it would need to determine if the rule should be implemented, amended or appealed. A new version of the rule, if indeed there is to be one, is likely to be much different than the current one.

The proponents of the California ballot initiatives are said to have spent $200 million in support of the measure, making it the most expensive ballot initiative in the state’s history. It would be surprising if they stopped there. Emboldened by their success, Uber and others in the industry are likely to pursue federal legislation that would explicitly recognize gig work as exempt from the protection of our labor laws, both federal and state.

[1] Oregon Bureau of Labor and Industries, Advisory Opinion of the Commissioner of Labor and Industries re: The Employment Status of Uber Drivers (Oct. 14, 2015). [2] McGillis v. Department of Economic Opportunity, 210 S.3d 220 (Fla. 3d DCA 2017). [3] Lowman v. Unemployment Compensation Bd. of Review, 235 A.3d 278 (Pennsylvania Supreme Court 2020). [4] NLRB Advice Memorandum re: Uber Technologies, Inc. (April 16, 2019). [5] Matter of Lowry (Uber Technologies, Inc.—Commission of Labor), 220 N.Y.App.Div. LEXIS 7854 (App. Div. Third Dep’t. December 17, 2020). [6] 4 Cal.5th 903 (2018). [7] California Labor Code §2750.3. [8] 29 C.F.R. Parts 780, 788 and 795. [9] McNamara, “Biden to Halt or Delay Trump’s ‘Midnight Regulations’ on Inauguration Day,” CBS News (Jan. 1. 2021).