The IRS and US states are tightening up how businesses define “employee” and “independent contractor,” and are looking at current classifications with greater scrutiny. For tax purposes, the IRS and states assume a worker is an employee unless proven otherwise. The burden to prove whether or not a worker is an independent contractor is on the hiring entity.
The ABC test is a new way to measure whether a worker is an employee or independent contractor. It was recently used in a California Supreme Court case regarding wage orders. Although each state is different, California’s ABC test provides a model that will likely lead the way in how businesses can classify their workers.
Let’s look at the three factors of the ABC test and how it affects your business.
A. Control and direction
To be considered an independent contractor, a worker must be free from control and direction of the hiring entity as it relates to the work. This includes excluding any control and direction outlined in the contract between the hiring entity and the contractor, and control and direction cannot be asserted in practice.
The IRS generally uses the “control and direction” metric to determine whether someone is an employee or an independent contractor. They evaluate three different types of control: behavioral, financial and relationship. Still, the IRS evaluates each case individually. Even if a contract states a worker is an independent contractor, the IRS may decide he or she is in fact an employee based on control and direction.
B. Work outside the course of the hiring entity’s usual business
Independent contractors perform work that is unrelated to the hiring entity’s usual course of business. If a widget company outsources their bookkeeping and contracts with an accountant, that worker is an independent contractor because he or she is not making widgets.
This factor arose when determining whether rideshare drivers are employees of rideshare companies. The business of the company is having its driver give people rides; therefore, anyone working to give customers rides on behalf of the company is acting as an employee.
C. Customarily engaged in an independent business
If the worker is customarily engaged in an independently established business, occupation or trade of the same type as the work performed, the worker is an independent contractor. This factor generally describes licensed professionals who have their own business and/or who maintain a portfolio of clients. A wide variety of professionals generally fit this category, including certified public accountants, estheticians and contractors.
What does the ABC test mean for your business?
Whether the ABC test impacts your business depends on where you live. Some states have adopted the ABC test as law, while others use it as a guideline for making determinations in cases like unemployment insurance eligibility. The IRS does not explicitly use the ABC test yet; it still relies on the control and direction factor.
If you work with independent contractors, you may wish to evaluate whether their work meets the ABC test. If not, you should consider whether that worker deserves to be an employee, or have his or her work altered to more appropriately fit the intended classification. If you fail to classify workers correctly, it could mean fines, retroactive wage payments and even a lawsuit. It’s always best to take any questions to an employment attorney.
If you’re looking for support keeping your payroll in compliance, MCG Solutions is here for you. Contact us today to get started.