Employers Beware of ABC and 123! Classification of Independent Contractors in California and Nevada – A Morass of Legal Tests

By: James E. Simon and David W. Wolfe

What do construction workers, realtors, gig economy workers, exotic dancers, hair stylists, and truck drivers have in common?  They all work in industries heavily dependent on the independent contracting workforce model. 

Under various California, Nevada, and Federal laws, a confusing array of criteria and legal tests are used to determine whether a worker is to be classified as an independent contractor or an employee in a variety of legal contexts.  This article will explain and analyze some of the different criteria and legal tests that are used by courts, legislatures, and certain government agencies.

The California “ABC” Test

Recently, California companies utilizing independent contractors have been severely impacted by the California Supreme Court decision in Dynamex Operations West, Inc. v. The Superior Court of Los Angeles County, 4 Cal. 5th 903In Dynamex, the Court set aside the broad multifactor “Borello” test previously used in California for determining whether workers are required to be classified as employees rather than independent contractors under California wage order laws.  Under the new “ABC” test established by Dynamex, workers are presumed to be employees rather than independent contractors unless the hiring entity can demonstrate by a preponderance of the evidence that: (A) the worker is free from direction and control of the hiring entity in the performance of the work, both under contract and in fact; (B) the work performed is outside the usual course of the hiring entity’s business; and, (C) the worker is customarily engaged in an independently established occupation or business that performs work of the same nature as the work performed for the hiring entity.  Each of the three “ABC” requirements must be met in order for an employer to rebut the presumption that a worker is an employee and not an independent contractor. 

The Dynamex Court reasoned that California labor regulations applicable to employees, but not independent contractors, were adopted to enable workers to earn a certain standard of living, to protect worker health and safety, and to shield the public from assuming the financial responsibility for substandard wages or unsafe working conditions.  Further, and maybe most important to old Uncle Sam, the misclassification of workers as independent contractors results in a loss of tax revenue.  For example, according to the California Labor Commissioner’s website, the misclassification of workers as independent contractors is estimated to cost California roughly $7 billion a year in lost payroll tax revenue.  It seems likely that the success and popularity of gig economy employers utilizing workforce configurations heavily dependent on the independent contracting model, such as Uber, Lyft, DoorDash, TaskRabbit, Freelancer, and Grubhub, focused the California Supreme Court’s attention on employment classification issues and guided the Court toward the more stringent ABC classification test.

The Dynamex ruling has led many California employers to question whether they should reclassify independent contractors as employees to mitigate the risk of costly litigation and stiff statutory penalties – between $5,000 and $25,000 per violation for willful misclassification.  Adding fuel to the fire, on May 2, 2019 the U.S. Court of Appeals for the Ninth Circuit in Vazquez v. Jan-Pro Franchising International, Inc., No. 17-16096, 2019 WL 1945001, held that the ABC test as set forth in Dynamex is a clarification rather than departure from established law, and therefore applies to employers retroactively.  The retroactive application of the Dynamex ABC test significantly increases employers’ potential risk exposure for misclassification, in part because statutes of limitation for wage claims can run as long as 4 years when pled as a violation of Business and Professional Code § 17200.  Dynamex could also increase employers’ potential risk exposure even in the non-employment context as it remains to be seen how the Dynamex decision will affect claims involving vicarious liability.  The California plaintiff’s bar may well buttress their arguments for favorable jury instructions on vicarious liability using Dynamex; while the defense will seek to limit the Dynamex ABC test as applicable only to claims made under specific employment and labor laws.

In fact, at least one appellate court has narrowed the scope of Dynamex by differentiating claims made under the Industrial Welfare Committee (IWC) Wage Orders and non-Wage Order claims.  The California Wage Orders subject to the Dynamex ABC test regulate basic working conditions for California employees, including minimum wage, meal breaks, and rest periods.  In Garcia v. Border Transportation Group, LLC, 28 Cal.App.5th 558, decided on October 22, 2018, the Court of Appeal for the Fourth Appellate District held that non-Wage Order claims, such as claims for reimbursement for certain expenses and wrongful termination, are not subject to the Dynamex ABC test, and are instead subject to the less stringent Borello test.  Further, the Court reiterated that despite Dynamex the proper test in California is still Borello for determining classification issues under the Worker’s Compensation Act.  

Meanwhile, the California Legislature is considering Assembly Bill 5, a bill designed to codify the Dynamex decision into law.  Businesses and industry groups, including large gig economy companies and the California Association of Realtors, are lobbying for exceptions that would allow classification of their workers as independent contractors.  On the other side, unions and worker advocate groups seek to maintain the California Supreme Court’s strict Dynamex ABC test for California industries.  The battle lines are clearly drawn as the legislative session heats up.

The Nevada “123” Test

In contrast to California’s ABC test, Nevada’s Legislature enacted Senate Bill 224, codified in NRS 608.0155, which became effective as of June 2, 2015.  NRS 608.0155 provides a relatively broad test for employers to classify independent contractors for purposes of Nevada wage and hour laws. Taking a very different approach than Dynamex, the statute creates what might be called a “123” test.  It is conclusively presumed that a worker is an independent contractor if the worker: (1) possesses, or has applied for, an employer identification number or a social security number, or has filed an income tax return for a business or self-employment with the Internal Revenue Service (IRS) within the previous year; (2) is required by contract with the principal to hold any necessary state or local business or occupational licenses, insurance, or bonding requirements, and; (3) meets three or more of the following criteria:

  1. The primary element bargained for in the contract is that the worker has control and discretion over the means and manner of the performance of any work and the result of the work;
  2. The worker has control over the time that the work is performed (subject to certain exceptions);
  3. The worker is not required to work exclusively for the principal (subject to certain exceptions);
  4. The worker is free to hire employees to assist with the work;
  5. The worker contributes substantial investment of capital in their business.

While the Nevada 123 test and the California Dynamex ABC test are used to classify workers for the purposes of Nevada and California wage and hour claims, as explained in the Garcia decision analyzed above, neither test is likely to affect the proper classification test to be used under federal laws or non-wage and hour state laws.  Another example is the test for classification in the context of the Nevada unemployment insurance tax which differs greatly from the Nevada 123 test in NRS 608.0155.  In the unemployment insurance context, the Nevada Department of Employment, Training and Rehabilitation utilizes the ABC test (similar to California’s test under Dynamex), as codified in NRS 612.085, to determine whether or not an employer’s payment for services is subject to state unemployment insurance taxes. 

Further, contrast the Nevada version of the “ABC” test as codified in NRS 612.085 with the test used for establishing an employment relationship for purposes of Nevada worker’s compensation laws.  The test related to Nevada worker’s compensation is described in NRS 616B.603, which generally defines an independent contractor as a worker who enters into a contract with the employer where the worker has an “independent enterprise” in a different trade, business, or profession than the employer.  NRS 616A.225 further defines “independent contractor” broadly as “any person who renders service for a specified recompense for a specified result, under the control of the person’s principal as to the result of the person’s work only and not as to the means by which such result is accomplished.”

The Feds Weigh In

Finally, Courts adjudicating claims under federal law are likely to utilize an entirely different approach.  For example, claims made under Fair Labor Standard Act (FSLA) will likely apply a 6-factor “economic realities test.”  Under the economic realities test, a court will generally consider the following factors to determine classification: (1) The extent to which the work performed is an integral part of the employer’s business; (2) Whether the worker’s managerial skills affect his or her opportunity for profit and loss; (3) The relative investments in facilities and equipment by the worker and the employer; (4) The worker’s skill and initiative; (5) The permanency of the worker’s relationship with the employer, and; (6) The nature and degree of control by the employer.  (Dare we call this the “Six Pack” test?)

The National Labor Relations Board (NLRB) is tasked with administration of the National Labor Relations Act (NLRA), including prevention of unfair labor practices and the safeguarding of employees’ rights to organize and decide whether or not to have unions serve as their bargaining representatives with their employers.  In the January 2019 decision SuperShuttle Inc. (16-RC-010963), the NLRB overturned an Obama-era NLRB ruling which made it more difficult for employers to classify workers as independent contractors.  In Supershuttle, Inc., the NLRB returned to the common law test which generally makes it easier for employers to classify workers as independent contractors.  The Supershuttle test analyzes multiple common law factors and emphasizes “entrepreneurial opportunity” as a principal by which to evaluate the overall effect of the common law factors.  Significantly, following Uber’s disappointing Initial Public Offering, on May 14, 2019 the NLRB general counsel stated in a memorandum that Uber drivers are independent contractors, and not employees, under the Supershuttle test.  The NLRB’s recent decision that Uber’s drivers are independent contractors may make it difficult for Uber drivers to unionize nationally or bring unfair labor practice charges under the NLRA. 

Continuing with the theme of a different classification test for each legal application, the IRS uses a test comprised of thirteen factors organized into three categories to determine if an employer must withhold income taxes and pay Social Security, Medicare and unemployment taxes on wages paid to an employee.  Of course, businesses normally do not have to withhold or pay taxes on payments to independent contractors.  The general IRS rule is that a worker is an independent contractor if the hiring entity has the right to control or direct only the result of the work, but not what work will be done and how it will be done.  The IRS will consider evidence regarding the degree of control in the employer/worker relationship by looking to a variety of factors organized under three broad categories: (1) Behavioral Control; (2) Financial Control, and; (3) Relationship of the Parties.  IRS Publication 15-A, the Employer’s Supplemental Tax Guide, is a good resource to help an employer understand the factors the IRS will look to in determining the classification of workers.  In addition, an employer can file Form SS-8 and the IRS will make a determination for the employer on the proper classification of a worker.

Conclusion

Companies in both California and Nevada that desire to enter into independent contractor arrangements with their workers should promptly and carefully review the status of those workers relative to each applicable classification test in advance of creating the relationship.  In California, with statutes of limitation for wage claims that can run as long as 4 years when pled as a violation of the Business and Professions Code, and where the recent Ninth Circuit decision in Vazquez held that the stringent Dynamex ABC test is to be applied to employers retroactively, such review is all the more critical. 

Companies in California that utilize workforce configurations heavily dependent on the independent contracting model likely need to adjust to a new employment reality sooner rather than later.  Although many of the industries utilizing independent contractors do not lack for lobbying clout, it might be an uphill battle for certain industries to pass legislation in California that would significantly alter the current Dynamex ABC employment classification test.  We will keep you posted.

The content contained and opinions expressed in this blog are solely those of the author. This blog contains content and opinions concerning the law generally, and is not intended to constitute legal advice or to create any attorney‑client relationship with the reader. The reader should consult with an attorney about any specific legal issues prior to embarking on any course of action or inaction involving legal matters. The author makes no claims, promises or guarantees about the accuracy, completeness, or adequacy of the contents of this blog and expressly disclaims liability for any errors and omissions.