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ABC test

What Is the ABC Test, and How Can Small Business Owners Comply?

The laws surrounding worker status have long been ambiguous. Deciding whether a worker is an employee or independent contractor has been largely left up to the employer’s discretion. Not anymore.

Thanks to California’s 2018 court ruling, workers are now presumed to be employees. After implementing a new ABC test as law, California has greatly limited the number of workers businesses can call independent contractors.

If you think that employers in California are the only ones affected by this benchmark ruling, think again. The ABC test is already in effect in Massachusetts and New Jersey. And, more than 20 states apply it in one form or another.

As the ABC test gains more and more traction nationwide, you may need to change how you classify your own workers. So, what is the test all about, and how will it impact your small business?

What is the ABC test?

The ABC test is a three-part test employers must meet if they want to classify a worker as an independent contractor.

The burden now falls on employers to prove workers are independent contractors. The ABC test makes it more difficult for employers to try to classify workers as independent contractors.

In 2018, California’s Supreme Court adopted the ABC test following the Dynamex Operations West, Inc. v. Superior Court of Los Angeles County case.

In the court case, delivery drivers who had worked for Dynamex sued the company for classifying them as independent contractors and not employees. Using the standards of the ABC test, the California Supreme Court ruled against Dynamex, saying that the workers should have been employees and not independent contractors. As a result, using the ABC test became law in the state of California.

Under the ABC test, a worker is only an independent contractor if they meet all three parts of the test:

  1. The worker is free from the control and direction of the hirer in relation to the performance of the work, both under the contract and in fact;
  2. The worker performs work that is outside the usual course of the hirer’s business; AND
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hirer

The second factor of this ABC test means you can’t hire someone to perform similar duties to that of your employees and expect them to be classified as an independent contractor. This greatly limits the types of workers you can hire as independent contractors.

If business owners are not able to prove that a worker meets all three prongs of this test, the worker is classified as an employee.

ABC Test

Examples of worker classification under the ABC test

Let’s take a look at two examples recorded in the court decision:

  • You hire seamstresses who work from home to design and create clothes you will sell in your clothing store. Because the ABC test clarifies that workers performing similar work to your business should be employees, you can no longer classify these seamstresses as independent contractors.
  • Or, let’s say you have workers who are contracted to create customized cakes for your bakery. They are performing employee duties, so you must classify them as employees under the new ABC test.

And, the ruling could impact companies like Uber and Lyft, who classify drivers as independent contractors. Because the drivers perform work that is in line with the business’s services, the companies may need to adjust how they classify their workers.

How does the ABC test impact employers?

Now to the crux of the matter—how does the ABC test influence you? Let’s start with the importance of correct classification.

Independent contractor vs. employee

There’s a huge difference between what you have to do when you have an employee vs. when you hire an independent contractor. Understand your employer responsibilities to learn what converting from contractor to employee truly means.

When a worker is an employee, you must follow employment laws, such as overtime and minimum wage laws.

You need to withhold and pay employment taxes on an employee’s behalf. Employment taxes you are responsible for dealing with include income, FICA, and federal and state unemployment taxes.

Also, you might offer employee benefits, such as retirement and health insurance plans.

When you have employees, you must obtain workers’ compensation insurance. Check with your state to learn if you must enroll in other programs, like state disability insurance.

California employers

The recent ruling from California’s Supreme Court could potentially impact business owners across the state. It does not just affect businesses in the gig economy.

Many employers in California who had previously classified workers as independent contractors may need to change that classification to a W-2 employee.

California employers will need to adjust their payroll if workers were previously misclassified. If you are an employer in California whose worker is now classified as an employee, you must start withholding and contributing taxes. And, you will need to sign up with accounts with your state, such as a new hire reporting account and a state unemployment tax account. Talk to your payroll service provider for more information.

One aspect which is unclear about the new ruling is whether employers in California will have to retroactively apply the new ABC test. Will employers adjust worker status for the remainder of the year, or will they owe back wages and taxes and be penalized for misclassifying workers prior to the Supreme Court ruling?

Beyond California

California isn’t the only state to rely on the ABC test. As stated, New Jersey and Massachusetts already use the ABC test.

And, some states use the ABC test for specific situations. For example, Maine uses the ABC test for unemployment compensation determinations.

It’s also speculated that more states will start following California’s official ruling in an attempt to limit the number of business owners who can call workers independent contractors.

Check with your state to find out if it uses the ABC test or some version of it. And, remain informed on new worker classification laws.

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This is not intended as legal advice; for more information, please click here.

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