This article was written by Henry Telfeian, a labor relations and employment attorney as well as the general counsel for the Professional Independent Consultants of America, Inc. (PICA Inc.). A graduate of Harvard Law School, he is an active member of the Supreme Court bar and an advocate for self-employed professionals. If you do not work in the United States, this blog doesn't apply.
About two months ago, the California Supreme Court issued a unanimous decision in the case Dynamex Operations West Inc. v. Superior Court that is likely to result in it being harder to qualify as an independent contractor.
More than ever, it’s critical that you take steps now to maximum your chances of passing what is likely to become a stricter vendor compliance process. Otherwise, it’s very likely that companies will demand that you do the work as a W-2 employee hired through a staffing agency. (Related video, “Friends Don’t Let Friends W-2”*)
Although this court decision directly affects only California companies, other states are likely to follow suit and use this ruling as a reference. At the very least, it’s likely to make employers in other States more cautious when hiring consultants as independent contractors.
How It Used to Be
Prior to the Dynamex case, California and other states had used a multi-factor test established by the California Supreme Court in 1989 in S.G. Borello & Sons, Inc. v. Department of Industrial Relations. Under Borello, the primary consideration in determining whether an employment relationship existed was whether the company had the right to control the manner and means by which the worker performed the work. Where control was lacking, a worker was likely to be found to be an independent contractor. In addition, secondary factors, such as the degree of skill required to perform the work, the method of payment, and the nature of the company’s business, could be considered in making the ultimate determination.
How It Is Now
Under the Dynamex ruling, for the California Supreme Court ruled that for the purposes of California Wage Orders (a subset of employment law) the hired worker is presumed to be an employee. The company has the burden of proving that the worker is an independent contractor by showing that a three-part test is met (the “ABC” test).
The hiring company must prove:
A. That the hired worker is free from the company’s control and direction both under the terms of any contract and in how the work is actually done;
B. That the work being done by the hired worker is outside the usual course of the company business; and
C. That the hired worker is customarily engaged in an independently established trade, business, or occupation of the same nature as the work he or she performs for the company.
Under the Wage Orders, all three parts of the test must be met in order to qualify as an independent contractor and be paid on a 1099 tax basis. In addition, there is now uncertainty as to what the California Supreme Court will decide when faced with the question of which test should be used with respect to other California labor and employment laws.
Understanding the “ABC Test”
The first requirement aligns with the previously established “right to control” test and is nothing new. The independent worker must control how, when and where the work is done. The company must only contract for the end product, not how it is achieved.
The second requirement means that the hired worker must perform work that is outside of the company’s business. In Dynamex, the company’s business was providing delivery services to various customers. Because the workers at issue were driving the trucks, the workers were performing work that was found to be part of the “usual course” of the company’s business. The Court’s reasoning focused on the hiring company’s “primary” business purpose. This reasoning is useful for independent consultants because you are being employed to provide consulting services which presumably are not in the usual course of the client’s business. For example, an organizational change consultant hired to provide consulting services to an apparel company would probably satisfy this part of the test even if the apparel company had an organizational effectiveness department because the company’s primary business is apparel, not organizational change services. On the other hand, this reasoning will be tricky if you hire subcontractors to help you with your work.
The third requirement of the ABC Test will be the most problematic for self-employed consultants. The California Supreme Court held that an independent contractor has ordinarily “been understood to refer to an individual who independently has made the decision to go into business for himself or herself.” Evidence of such activity usually consists of “incorporation, licensure, advertisements, and offering to provide services to the general public or potential customers.” In addition, the California Supreme Court referenced decisions from other courts that relied on such factors as: having business cards, sending invoices prior to payment, having a business telephone, having a business location, and being paid by more than one entity. Although the Court made it clear that none of these particular actions are required to prove that an individual is engaged in an independent business, it is clear that in the absence of these factors, or many of them, the courts will be reluctant to conclude that the individual is engaged in an independent business.
It’s because of this third part of the test that you need to pay attention to how you operate.
Actions to Take to Preserve Your 1099 Tax Status
1. Form a Limited Liability Company or incorporate. While operating as a sole proprietorship is certainly legal, it may not be enough evidence under the ABC Test.
2. Register a DBA (“doing business as”) with your local city/county. Registering a DBA usually costs less than $100.
3. Get all appropriate business licenses. The Small Business Administration is a good place to start.
4. Get a Federal Tax ID number (EIN) from the IRS. It’s easy and free to get an EIN online at IRS.gov.
6. Get a dedicated business phone number. See “The Best Business Phone Service Providers of 2018” for ideas.
7. Use your own web domain and business email account, not Gmail or Yahoo. (See related blog here.)
8. Offer your services to the general public, for example, have a website.
9. Use a written contract with every client ensuring, among other things, that you as the consultant retains control over the manner and method of performing any work.
10. Advertise. For example, use Google Adwords and take screen shots as evidence.
11. Establish social media pages for your business, for example on LinkedIn.
12. Submit invoices to the client for all amounts due, not time sheets.
13. Have more than one client, preferably at the same time.
14. Don’t work exclusively for one company or for a long period of time.
15. Have a business address, even if it’s a P.O. box.
16. Be a member of professional associations related to your business. Not only does it help to satisfy the ABC Test, it’s tax deductible and you might learn something. [Shameless plug: The Professional Independent Consultants of America is an excellent choice. 20% discount code for blog subscribers: 18BL20A]
Bottom line, the Dynamex decision has made a bad situation worse. Companies will be hesitant to hire individuals as independent contractors and instead will force them into a temporary W-2 relationship.
Take steps now to improve your chances of remaining independent. The longer you can show that you have been engaged in an independent business, the more likely that the ABC test will be satisfied. There’s an old saying, “If it looks like a duck, walks like a duck, and quacks like a duck, then it’s a duck.” The same is true now for self-employed professionals. You need to look like a business, be set up like a business, and act like a business in order to be paid like a business.
* "Friend's Don't Let Friends W-2" is trademarked. All rights reserved.
CAVEAT: This blog article provides information about a specific state court ruling. It is not intended to be, and should not be construed, as legal advice for any particular fact situation. Your situation depends on your particular facts. Reading a summary of a specific court decision is no substitute for consulting with, and obtaining the advice of a qualified employment attorney in the State or States in which you work and reside. Only an attorney can provide you with legal advice for your particular situation.