The employment landscape is changing. In 2019, 44 million people in the United States – 28.2% of workers – reported that they were self-employed, while 14% of workers reported that being an independent contractor was their primary source of income.[1] This trend can be partially explained by COVID-19 and its resulting economic downturn, but this reality has been a long time coming.

Gig work allows independence and flexibility on the part of the worker, and it allows the hiring business to streamline the hiring process, staff projects according to immediate needs and changes in demand, and ultimately avoid a lot of the burden that comes with managing a team of employees.

As the labor landscape continues to shift, however, there are countless new legal questions that continue to crop up. Attorneys representing businesses or workers should be aware of the current framework for independent contractors.

Employee or Independent Contractor? The difference is cloudy.

Though distinguishing between an independent contractor and a regular employee may seem obvious on its face, classifying workers correctly can be very cloudy in practice, and the consequences of a business misclassifying its workers can be severe.

At a high level, the main difference between an employee and an independent contractor is that the independent contractor is not entitled to many of the legal protections that would be provided to an employee. In Dynamex Operations West, Inc., the California Supreme Court provided:

In addition to the payroll taxes, unemployment and state taxes, and workers’ compensation, the federal statutes and regulations this case refers to are almost countless. Discrimination, wage and hour, worker safety, collective bargaining – these are only a few of the facets of employment laws where independent contractors do not enjoy the same rights and privileges as regular employees.

Because of these monumental differences, it is critical that employers know how to properly classify their workers, and equally important that businesses’ attorneys know how to audit these classifications.

Classifying Workers – a muddled framework

Unsurprisingly, the framework for classifying workers is somewhat muddled across state and federal law, and even among federal laws. There are multiple tests to determine whether a worker is an employee or an independent contractor, and different federal statutes sometimes require the application of different tests.[2]

The Common Law Test

Most federal statutes apply the common law test. Under the common law test, which is used for purposes of federal taxes, examines the level of behavior control and financial control the employer has over the worker, as well as the contractual relationship between the parties.

According to the Internal Revenue Service (IRS), this test can generally be summed up according to the following guidelines:

Behavioral control considers the type and degree of instructions that the employer must give to the worker, how the worker is evaluated, and whether the employer trains the worker. Financial control looks at how the worker is paid, whether the worker can seek outside work, whether the employer reimburses the worker for expenses, and how much investment the employer puts into the worker. Finally, the type of relationship looks at how permanent the relationship is, whether it is subject to a written contract (versus an at-will-type arrangement), whether the worker receives benefits from the employer, and whether the service is a key aspect of the business.

The Economic Realities Test

Under the Fair Labor Standards Act (FLSA) and Family and Medical Leave Act (FMLA), the Department of Labor’s regulations classifies employees based on the “economic reality” of the relationship, rather than the common law standards. There is no single test, but the Supreme Court has considered the following factors in determining whether the FLSA applies:

The Wage and Hour Division has reported that some of the most common issues in classifying employees as independent contractors rather than employees arise in the construction industry, with volunteers, students, and trainees, and work-from-home employees. These are a few of the many factors employers should be considering when classifying their employees for purposes of state and federal regulations.

The California Way: The ABC Test

California has made waves in regulating the gig economy. In 2018, the California Supreme Court decided Dynamex Operations West, Inc. v. Superior Court of Los Angeles.[5] The case reframed the test for how to classify independent contractors and employees for purposes of California’s wage laws. The test established by the Supreme Court provides that, in order to classify a worker as an independent contractor, the employee must show the worker is:

This test creates a presumption that a worker is an employee, so the burden falls to the employer to prove that they are an independent contractor. The ABC test is also used in Illinois, Massachusetts, and New Jersey.

The Future of Regulating the Gig Economy

Although California’s test is more worker-friendly than the other standards, it may have a significant impact on the future of how gig workers are classified. Under the Trump administration, the Department of Labor rolled back regulations ostensibly to make it easier for employers to classify workers as independent contractors. In May 2021, the Department rescinded the rule and restored the economic realities test described above.[6] The constant fluctuations in both regulatory and case law can be burdensome for employers to remain compliant. Each time the law changes, companies must revamp their human resources policies, reprogram HR systems and hiring practices, and update workers’ benefits, wages, and tax withholdings.

Meanwhile, the risks of non-compliance cannot be overstated.

Employers can run into serious tax trouble for failing to withhold employees’ taxes, including being liable for unpaid FICA taxes, as well as state and local taxes. Misclassified employees also expose businesses to an increased risk of litigation over issues like unpaid wages, overtime, ERISA, and countless other worker protections. Beyond civil liability, in some cases, employers can even be subject to criminal penalties for willfully violating the Fair Labor Standards Act.

Unemployment Benefits for Gig Workers?

Independent contractors have historically not been eligible for unemployment benefits. Businesses hiring independent contractors do not have to pay payroll taxes for them, so the unemployment insurance pool does not contemplate and account for these workers. However, the CARES Act offered pandemic unemployment assistance to independent contractors if either the contractor lost their job as a result of COVID-19, or if they had been incorrectly classified as an independent contractor but were really an employee. Some are calling for a permanent expansion of the safety net for independent contractors. Currently, no states offer unemployment compensation to independent contractors outside of the special Coronavirus litigation.

The key takeaway for employers and attorneys representing employers: make sure to classify employees correctly for the correct purposes. Classification systems should be regularly audited to help minimize the risk of employment litigation or civil penalties. Continue to look out for changes to the law as the gig economy continues to grow and a pro-labor administration strengthens worker protections.