Major Change in California Independent Contractor Classification Rules

By Rachel Rabindran, Accounting Consultant

UPDATE—In September, 2019 the Governor signed Assembly Bill 5 that codified the ABC tests used in the Dynamex case to determine when a worker is an employee or independent contractor. In September, 2020 the Supreme Court decided to hear the appeal of Vazquez v. Jan-Pro Franchising International, Inc. to determine if the Dynamex decision can be applied retroactively. See our most recent blog post for more details about how these actions will impact your business: Reclassifying Workers as Employees Under AB 5.

In April, 2018 the California Supreme Court issued their long-awaited ruling in a class action lawsuit concerning delivery drivers. The court unanimously ruled in Dynamex Operations West, Inc. v. Superior Court of Los Angeles County that a worker will be considered an employee of the hiring entity unless the hiring entity can establish all three of the following factors (also known as the “ABC test” to identify independent contractors):

    1. The worker is free from the control and direction of the hiring entity in connection with the performance of the work – essentially no supervision should be exercised by the hiring entity.
    2. The worker performs work that is outside the usual course of the hiring entity’s business – hiring an individual who is essentially performing the same functions/services as existing employees will fail this test.
    3. The worker is customarily engaged in an independently established trade, occupation, or business – the worker needs to have business separate from the services rendered to the hiring entity.

The burden of meeting all three factors is strictly on the hiring entity. The hiring entity’s failure to meet any one of the three requirements will be sufficient in itself to establish that the worker is an employee and cannot be classified as an independent contractor.

The court joined approximately 20 other states in adopting some form of the ABC test and rejected the previous multi-factor test that had been used for over twenty-five years. Under the multi-factor test, no single factor was determinative.

As of November, two significant questions raised by the ruling still remain unanswered. It is still unclear exactly which employers are impacted by the ruling and if the ABC test will be applied retroactively.

Although the California Employment Development Department (EDD) has not released an official position, it has indicated informally that it will apply the ABC tests of Dynamex only to employers with a similar fact pattern (employers in the transportation industry). This doesn’t mean the EDD’s position won’t change in the future. In addition, the courts and the California Industrial Welfare Commission may expand the use of the ABC test for worker classification. For further confusion, the court applied the ABC tests for purposes of minimum wage, overtime rules, and certain working conditions. It did not address if these tests should be applied to determine employee status for purposes of employee benefits, employee expense reimbursements, workers’ compensation insurance coverage, or employer payroll taxes.

After the ruling, business groups pressed the Supreme Court to clarify whether its decision applied retroactively, but the Court denied petitions for rehearing and refused any efforts to reconsider or amend its original decision, which did not address retroactive application. If courts support retroactive application, it could be a major disaster for California businesses. They would be open to lawsuits by individuals correctly classified as independent contractors in prior years under the multi-factor test but who now, according to the ABC test, should be treated as employees.

In a recent case (Johnson vs. VCG-IS, LLC, et al), an Orange County judge ruled that the Supreme Court’s decision in the Dynamex case does apply retroactively and does not apply to only transportation industry workers. The court applied the ABC test to determine that the independent contractors in question (exotic dancers) should be classified as employees. California courts could follow the Orange County decision and rule similarly on a case-by-case basis, further expanding the use of the ABC tests.

Businesses need to closely monitor how courts and the EDD apply the ABC independent contractor tests and review their current methods of determining independent contractor status in light of the court’s ruling. Expanding the use of the ABC tests would significantly limit who could qualify as an independent contractor. We encourage all employers to consult with their labor law counsel for further guidance and please feel free to reach out to our team at ASL with any additional questions.