On April 30, 2018 the California Supreme Court passed down a ruling that redefined how employers classify workers. The New York Times described the decision as a “blow” with “potentially sweeping consequences” to the gig economy and a “game-changer,” while The Mercury News called it an “earthquake.”
Yes, this ruling is significant, but to be honest, calling it a “seismic shift” is an exaggeration. The “new” standard is not dramatically different or more stringent than the old one. The main reason the decision is significant because it shows that state governments and court systems are placing close attention to worker classification and compliance, and not just for the gig economy. Highly skilled freelance professionals are just as affected as Task Rabbits and Uber drivers.
Freelancers vs Independent Contractors vs Employees
For companies that work with independent contractors, this decision is a sign that there is no room for error and no room to hide. Employers that misclassify workers will face consequences. Compliance has to be a top priority for any business with a blended workforce.
This particular case was brought by delivery drivers at a company called Dynamex. The drivers had previously been considered full-time employees and then the company changed the relationship to contractors in 2004. The California Supreme Court, in essence, was tasked with determining how to classify workers. In an 85-page ruling, the court rejected the multi-part existing standard that relied on around 10 criteria, including the amount of supervision, whether a worker can be fired without cause, and the permanency of the relationship.
It replaced the standard with the simpler “ABC Test,” which is already widely used for state unemployment purposes and applied in Massachusetts and New Jersey. Under the ABC Test, the worker is considered an employee if they perform a job that is part of the “usual course” of the company’s business. To truly be an independent contractor, a worker must also be free from any control or direction in performing the services and customarily engaged in an independently established profession or business.
Why is the ruling being treated as such a big deal?
In theory, it makes it more difficult for companies to classify workers as independent contractors. Treating workers as employees costs roughly 20 to 30 percent more than classifying them as contractors because employers have to follow minimum-wage and overtime laws, as well as pay workers’ compensation, unemployment insurance, and payroll taxes. ICs are cheaper, and so companies like Uber and GrubHub that rely on cheap labor may find their business models on shaky ground.
“While companies like Uber have had some success arguing that they don’t exert sufficient control over drivers to be considered employers, it would be hard to assert that drivers are performing a task that isn’t a standard feature of their business,” the New York Times article said.
However, as University of San Diego law professor Orly Lobel, a labor law specialist, pointed out to The Mercury News, things won’t change overnight.
“I don’t think we shall see voluntarily change — reclassification by any of these companies — anytime soon and I also don’t think they will change easily even with the initiation of a lawsuit. It would probably take a state regulator … to force change, but I don’t predict that happening soon,” she said.
Workers who think they are misclassified still have to file complaints with the labor commission or sue in order to get a decision and create change. While states that administer the ABC Test generally lean towards finding workers to be employees, there is still a gray area. Classification questions aren’t easy and it remains possible to debate what the “usual course of the company’s business” means into eternity, as companies like Uber are likely to do.
That said, this court ruling makes it clear that to classify workers as independent contractors, businesses need to have receipts—they need to show how and why they determined classification. A judge and/or an auditor, whether from the IRS or the Department of Labor, will demand evidence that a worker really is an independent contractor. The fine for misclassifying one freelancer is $35,000. For a company with 100 freelancers—not an unusual amount—that could mean $3.5 million in fines. It’s important to err on the side of caution and make compliance a priority.
What can businesses do?
Given how many different data points are involved in determining worker classification, companies need a Freelance Management System (FMS) and strategy for gathering, storing, and updating information about their freelancers on a continual basis. From onboarding to payment, visibility is key, and spreadsheets don’t cut it. Reducing liability risk requires bringing all the information into one, indexable place and using technology to identify potential red flags. Decisions like the California ruling are likely to keep happening, as the freelance economy is only growing bigger.
New to Freelance Management Systems: Check out our resource - What is a freelance management system?
To learn more about how can businesses scale their freelance workforce while also ensuring they maintain employment and tax compliance, check out this guide to compliance from Kalo. It helps businesses understand the risks of freelancer misclassification, the criteria the government uses to determine if a worker is a freelancer or a full-time employee, and how to adopt best practices and technology to reduce compliance risk.