Apps enticing gig workers to offer their talent and services on the open market are being developed and introduced daily, and U.S. workers are hooked on the autonomy these opportunities provide. Before the COVID-19 pandemic, approximately 57 million U.S. workers dabbled with gig work, and polling suggests that number will grow to a staggering 76.4 million by 2024, according to Forbes.
The proliferation of gig work is undeniable, is changing how people support themselves, and is disrupting traditional notions of “employment.” Many industries are experiencing a need or a desire to engage gig workers and, as a result, the opportunity to perform gig work is growing.
Generally, gig workers exercise control over the amount of work they accept, they are paid for a discrete task, and the nature of the work is short-term but is often repeatable. Some gig workers are treated as employees, while others are treated as independent contractors. This article focuses on the latter.
Independent contractor misclassification occurs when a hiring entity treats a worker as an independent contractor when the worker is an employee under the law. The most common consequences of misclassification include wage and hour violations, as well as deprivation of health, retirement, leave, disability, and social welfare benefits. Misclassification can also cause regulatory issues for a hiring entity, including audits and investigations arising at the state and federal agency levels.
Several states have commissioned task forces to evaluate the social, economic, and governmental impact of independent contractor misclassification. States’ responses to these findings have varied substantially, with some states amending their laws and others initiating stronger enforcement efforts.
Recently, the federal government has also focused on misclassification by issuing a memorandum of understanding issued jointly by the U.S. Department of Labor (DOL) and Internal Revenue Service that explains the agencies’ intent to share information about companies found to have misclassified employees as independent contractors. This enforcement effort was announced after the DOL issued a similar memorandum with the National Labor Relations Board (NLRB).
Because there is no single test to evaluate independent contractor status, the hiring entity must look to the specific context in which the relationship arises to determine which test applies. The primary governmental agencies responsible for administering the various laws include: the Internal Revenue Service and state taxing authorities; the federal and state departments of labor; state unemployment and workers’ compensation agencies; federal, state, and local anti-discrimination agencies; the National Labor Relations Board; and the U.S. Immigration and Naturalization Service.
Although different statutes govern the test under which employment status may be evaluated, the various tests share some characteristics, such as the degree of control the company has over the manner and means by which the worker accomplishes the work.
Notably, no test considers the hiring entity’s and worker’s characterization of the relationship as conclusive, even when the parties have memorialized independent status in a written agreement.
The “ABC Test”
The “ABC Test” is the most difficult of all formulations of the test of independent contractor status. Under this test, the hiring entity must show that a worker meets three criteria in order to lawfully provide services as an independent contractor:
- The work must be free from the control and direction of the company in connection with the performance of the work, both under the contract for performance of the work and in fact;
- The worker performs work that is outside the usual course of the hiring entity’s business; and
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
When applying the A-Prong of the test, courts and regulators alike generally ask whether the hiring entity retains a practical right to control how the bargained for service is accomplished. Evidence of the contractual obligations and the circumstances surrounding the relationship will be considered, and the hiring entity will be expected to develop evidence of freedom from control in both circumstances.
Under the B-Prong, courts have found that the more important a worker’s services are to the core business operation of the hiring entity, the more likely that worker is to be considered an employee.
The C-Prong focuses on whether the worker is operating a business that, from a practical perspective, is independent from the hiring entity’s business. Most jurisdictions applying the ABC Test have determined that merely abiding by corporate formalities, however, is not enough to satisfy the C-Prong, instead requiring some evidence the worker is operating a going concern.
The “Economic Realities Test”
Another test for determining independent contractor status is the “Economic Realities Test.” This test asks whether, given the totality of circumstances, the worker is as a matter of “economic reality” operating independently from the hiring entity.
The following factors are generally considered when applying this test:
- the degree of control exercised by the hiring entity over the worker;
- the skill or initiative necessary for the worker to complete the services;
- the permanency of the relationship;
- the opportunity for the worker to generate profit and/or loss for itself;
- the workers’ investment in equipment and resources to complete the services; and
- whether the service performed by the worker is an integral part of the hiring entity’s business.
The more control, less skill, more permanency, less opportunity, less investment, and greater reliance on the worker’s service to aid the hiring entity’s business, the more likely a worker will be considered an employee.
Because there is no single articulation of the test, the DOL sought to establish a uniform federal standard to be applied in the context of enforcing the Fair Labor Standards Act and Family and Medical Leave Act. The current state of this rule is in flux.
For now, the DOL determines independent contractor status by first considering the degree of control and opportunity for profit or loss, and only if those factors are inconclusive, it will consider the remaining factors. The Biden administration is expected to introduce a new proposed rule, but it has yet to do so.
Other laws incorporate multi-factor tests. The IRS, for example, developed the most prominent multi-factor test decades ago. Under this “20-Factor Test,” the IRS considers employment status in the context of three categories: behavioral control, financial control, and the nature of the parties’ relationship.
This multi-factor approach contains elements from the tests articulated above, and adds considerations such as the substitution of labor, the level of instruction given by the hiring entity, who bears the expense of performing services, the level of investment by the worker, the manner of pay, and the hiring entity’s provision of benefits to a worker. (Nothing in this discussion should be construed as a formal tax opinion and may not be relied upon to support a company’s reporting or tax position. Please seek the advice of qualified tax counsel for any tax compliance issues.)
The “Restatement Test” is another prevalent multi-factor test. This test considers the following factors:
- the extent of control, which by agreement, the hiring entity may exercise over the details of the work;
- whether or not the one employed is engaged in a distinct occupation or business;
- the kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the employer or by a specialist without supervision;
- the skill required in the occupation;
- whether the employer or the workman supplies the instrumentalities, tools and the place of work for the person doing the work;
- the length of time for which the person is employed;
- the method of payment, whether by the time or by the job;
- whether or not the work is part of the regular business of the employer;
- whether or not the parties believe they are creating an employment relationship; and
- whether the principal is or is not in business.
Given these tests and their relative complexity in application, hiring entities need to be cautious of relying on “common industry practice” as the various legal tests do not consider this to be a relevant factor.
In sum, it is imperative that a hiring entity carefully review its business model and thoroughly review whether engaging independent contractors is a sustainable practice for the business by evaluating whether:
- workers are properly classified considering the relationship;
- changes in practice could support independent contractor status;
- agreements adequately define the relationship; and
- the model, overall, can withstand challenge under the most stringent test that is implicated in the circumstances.
The evaluation and plan of action for each of these will necessarily be unique to the individual business circumstances and require critical analysis and implementation.