To designate as an employee or not to… this is the question that plagues many small businesses. In California, the distinctions between full-time employees and independent contractors are getting a makeover, with serious legal and tax implications.
On April 30th, 2018, the California Supreme Court ruled in Dynamex Operations West, Inc. v. Superior Court, a case that hinged on whether a group of delivery drivers should be classified as employees or contractors. As a part of the decision, the court set forth a new set of rules — called the “ABC Test” — for determining how a worker should be classified when wage orders apply (in other words, when they’re paid hourly and an industry legal standard is in place).
For businesses in California, the ABC Test helps to demystify the process of classifying workers, making filing taxes less stressful for business owners. Read on to find out more about the new ABC Test, and how it could help you file your business taxes.
Using A Less Complicated Evaluation
The chief takeaway from the Dynamex ruling is that employers must consider hourly workers as employees, unless they meet all three of the outlined criteria for independent contracting.
This isn’t a huge change from the principles of the Borello Test (the previous standard), which also leaned heavily toward considering someone an employee. The differences in the new test lie in the level of complexity. If you’ve felt overwhelmed in the past when determining the status of a worker, you may have an easier time now.
Out With The Old…
As the prior standard, the Borello Test consisted of a whopping 11 unique elements. Employers often had trouble navigating these rules, because they covered a wide range of factors and many of the list items were vague. To make matters more complex, the law stated that a worker didn’t need to meet all 11 elements to be considered an employee.
If you’ve been paying independent contractors, you’re probably familiar with using the Borello Test to evaluate things like:
- How long services will be performed
- The degree of permanence of the working relationship
- The worker’s financial investment in the equipment used to complete the work
- The payment method by time or job
…In With The New
Under the new ABC Test, you only need to assess three questions (or elements) to determine whether a worker is an independent contractor. Your independent contractors will often offer a specialized skill, and to be classified as such, you must be able to show that they:
- Are free from the control and direction of your company in connection with the performance of the work
- Do work that is outside the usual course of your business
- Are engaged in an independently established trade or business of the same nature as the work they do for you
Another major difference is that the worker must meet all three elements of the ABC Test to be considered an independent contractor; you can be challenged if they fail to meet even one aspect of the test.
Deciding which classification your worker fits into will determine whether you need to give them a W-2 and enter them into payroll; or, offer them periodic payments and send a 1099 at the end of the year. The long and short of it? With fewer variables at stake in the ABC Test, the often-confusing process of figuring out who is a contractor is growing simpler.
Updating Your Worker Classifications
If your small business employs anyone by the hour — from a driver to a seamstress — and they conduct work that is a part of your regular business, you may have to change their classification from contractor to employee. While this means some paperwork and renegotiations now, it will make your taxes easier to file in the long run. Having your workers properly assigned saves you the headache of the IRS fining you for sending someone a 1099 who should have been given a W-2.
So, while the ABC Test requires you to reevaluate your workers and possibly reclassify some of them now – it’s a blessing in disguise in the long run. It will be easier to determine whether someone belongs on your payroll, and head into tax season with your ducks in a row. Keep in mind that wage orders dictate rest periods, overtime, and more — so whenever you move someone from a contractor to an employee, you should reach out to an HR professional for help making the transition seamless and entirely legal.
Filing Your Taxes Moving Forward
If you do have to reclassify your incredible hourly designer, long-time marketer, or another worker essential to your business, don’t worry. Here are the first steps you should take, to make sure your taxes are easier to file:
- Scrap their old contract and renegotiate a new one with their new hourly rate and benefits defined. Clearly indicate the date change in their employment status.
- Add the worker to your payroll. This is the most crucial step, because it begins deducting their taxes automatically and will generate their W-2 at the end of the year.
- Offer the worker all benefits available to other employees. Once an independent contractor has employee status, you must provide them the same advantages available to all employees who work the same hours they do. (Note that part-time and full-time employees often have very different benefit packages, and the ABC Test does not require you to offer full-time benefits to your part-timers.)
With these changes in place, you will have a much easier time filing small business taxes this year and avoid making mistakes. Still have questions about the tax implications of the new ABC Test for California employers? Contact your accountant or tax law professional to get expert advice on determining employment status for workers bound by a wage orders. A bit of paperwork now means breezy taxes later.
