California Supreme Court Adopts “ABC Test” for Independent Contractors
On April 30 the California Supreme Court issued an opinion in Dynamex Operations West, Inc. vs Superior Court adopting the “ABC Test” for determining Independent Contractor status. Unlike some of the more ambiguous tests used by the IRS and the Department of Labor, this test provides a clear line for employers in determining who is and is not an Independent Contractor.
Significantly it presumes that all workers are employees unless all of the following three tests are passed:
A. That the worker is free from the control and direction of the hiring entity relating to the performance of the work, both under the contract for the performance of the work and in fact; and
B. That the worker performs work that is outside the usual course of the hiring entity’s business; and
C. That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
Failing any one of these tests means that the worker is an employee.
Given that the nature of freelance work in the production of film, video, print for advertising and entertainment clearly falls under the “B” test, it is unlikely that any typical freelance engagement will pass this Independent Contractor test. It should be noted that twenty-four other states also use this basic ABC test in regard to state taxation.
What are the risks?
Under California regulations, payments to Independent Contractors are substantiated by the filing/issuing of an IRS 1099 Form. These Forms are subject to audit. Should a California audit determine that any paying entity misclassifies a worker as an Independent Contractor, the employer is subject to fines of $5,000- $15,000 per 1099.
These penalties can be increased up to $25,000 per 1099 should it be determined that there was an intentional “pattern or practice” involved. There are also potential penalties for individuals who knowingly advise an employer to misclassify employees.
These penalties are in addition to potential claims and penalties for unpaid employer unemployment and workers compensation insurance premiums as well as employee claims of unpaid overtime wages and related penalties.
The State of California works closely with the IRS on misclassification issues. As a result, an audit in California will likely trigger an IRS audit which could carry further claims of unpaid employer payroll taxes and penalties.