Clearing the Confusion of Worker Classification

Remember, this final rule only affects decisions under the Fair Labor Standards Act and may not be applicable under state or local requirements for determining worker classification. Businesses should consider and use all applicable tests to determine the proper classification based on the worker’s jurisdiction. This final rule adds additional impact to an ever-evolving world of employment-related requirements where businesses are continually challenged to classify their workers correctly, and misclassification can lead to claims and penalties. While the new federal rule is in place, many states in the U.S. have already adopted the ABC test as the standard for determining the proper classification of workers, which is generally considered to result in more workers being classified as employees than independent contractors compared to the six economic reality factors test. Learning the ABCs of worker classification can be valuable in helping you get a jump on staying compliant.

The ABC test is a standard used by various states to determine whether a worker should be classified as an employee or an independent contractor. It is a stringent test that sets specific criteria for a worker to be considered an independent contractor and could be used by any business to evaluate classification. For a worker to be classified as an independent contractor under the ABC test, they must meet all three of the following criteria:

A. Control: The hiring entity does not have control or direction over the worker in terms of how they perform their work, both practically and contractually.

B. Business Nature: The work performed by the individual is outside the usual course of the hiring entity’s business.

C. Independent Business: The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.

A. Control

One of the primary factors in the ABC test is the type and level of control the hiring entity has over the worker. This goes beyond just telling the worker what needs to be done; it involves the type and degree of controlin terms of how the work is performed. Independent contractors are expected to have control over the methods and details of their work, while employees typically work under more direct supervision. However, depending on the nature of the work and overall arrangement between the parties, a business need not control the precise manner or details of the work to be found to have maintained the necessary control that an employer ordinarily possesses over its employees. To avoid misclassification of independent contractors, businesses typically should ensure that their independent contractors have the autonomy to determine their own work hours, methods and tools, among other determinations. Clearly defined contracts that emphasize the independent nature of the relationship can also help support the claim that the worker is not under the control and direction of the hiring entity.

B. Business Nature

The second criterion of the ABC test examines whether the work performed by the individual is outside the usual course of the hiring entity’s business. In simpler terms, if the worker is performing tasks in a role comparable to that of existing employees, they will likely be viewed as working in the usual course of the hiring entity’s business and thus more likely should be classified as an employee. For example, if a software development company hires a programmer to help create a new software application, that programmer’s workis likely considered part of the hiring entity’s usual course of business. On the other hand, if the same software development company hires a plumber to fix a leak in the office, the plumber’s work is outside the hiring entity’s usual course of business and may pass the test for independent contractor status.

C. Independent Business

The third prong of the ABC test focuses on whether the worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work they are performing for the hiring entity. This criterion assesses whether the worker is truly operating as an independent business entity or is instead economically dependent on the hiring entity. To meet this criterion, independent contractors should be able to demonstrate that they have their own clients, business licenses, routine offerings to provide the services of their independent business to the public or to a number of potential customers or other indicators of an independently established business. This helps establish that the worker is not an employee in disguise but is genuinely in business for themselves. Note that the hiring entity usually must prove the independent business operation is actually in existence at the time the work is performed.

While the ABC test provides a clear framework for worker classification, challenges and gray areas can exist. Some industries inherently blur the lines between employees and independent contractors, leading to confusion and disputes. Additionally, the interpretation of the ABC test can vary between states. Some state courts and agenciesinterpret the three prongs of the ABC test differently than other states. Finally, keep in mind that the federal DOL final rule will restore the historical six economic reality factors test for determining worker classification at the federal level and that some states have either adopted that test or another standard besides the ABC test to determine work classification. Businesses operating in multiple states must navigate a patchwork of requirements, further complicating the already challenging task of proper worker classification. That’s why it is critical to seek the help of a legal professional when evaluating worker classification.

The consequences of misclassifying workers can be severe for businesses. Legal action may result in fines, penalties, interest, and potential back payments for regular wages, overtime wages, benefits and taxes. In addition to financial repercussions, misclassification can damage a company’s reputation and lead to increased scrutiny from regulatory bodies. Moreover, misclassified workers do not receive the protections and benefits they would otherwise have been entitled to under employment laws. This includes minimum wage, overtime pay, workers’ compensation, unemployment insurance benefits and other crucial safeguards.

To help avoid the pitfalls of misclassification, businesses can implement several best practices:

• Regularly review worker classifications: Work relationships can evolve over time and what may have started as a properly classified independent contractor relationship could morph into an employer-employee relationship that’s now improperly classified. Regularly reviewing worker classifications can help identify changes in the nature of the work relationship and allow you to timely change worker classifications as needed.

• Consult legal professionals: Given the complexity and constant evolution of employment laws and the potential consequences of misclassification, it is advisable for businesses to seek legal counsel to determine worker classification. Employment attorneys can provide guidance tailored to the specific circumstances of the business.

• Maintain clear contracts: Well-drafted contracts can help establish the independent nature of the independent contractor relationship. Contracts should clearly outline the expectations, responsibilities and autonomy of the independent contractor, among other provisions.

• Document working relationships: Maintaining records of the working relationship, including invoices, communications and project agreements, can provide evidence of the independent contractor’s classification.

• Provide training: Ensuring that managers and human resources staff are well-trained on employment laws and worker classification can help prevent inadvertent misclassification. Education and awareness are key components of compliance.