The ABC’s of (mis)classifying staff

Corey L. Rosenthal, JD, and Lance E. Rothenberg, JD, LLM

Whether or not a employee is satisfactorily certified and handled as an worker or as an impartial contractor is a fancy however more and more necessary inquiry for employers and their advisers. Pushed by the COVID-19 pandemic, the continued growth of the gig economic system and the fast shift to distant work are two elements drawing elevated consideration to those points.

Federal and state guidelines fluctuate, however enforcement of employee misclassification is turning into a rising precedence for presidency auditors. In New Jersey, there have been a couple of notable developments, together with the current $100 million cost by Uber Applied sciences, Inc., to resolve an unemployment insurance coverage audit for employee classification, the biggest cost of this kind within the historical past of the state.

Primary notions on the classification of staff

Correct classification might be obscure, as a result of there are sometimes overlapping however completely different exams relying on the difficulty (e.g., revenue tax, payroll tax, unemployment insurance coverage, wage and hour) and authorities company (e.g., taxes, labor , federal, state) in query, which might result in completely different outcomes. Usually, nonetheless, all classification guidelines study these two sides of the identical coin: 1) the diploma of independence of the employee from the payer and a pair of) the diploma of management of the payer over the employee. Staff work for and underneath the supervision of their employers, who management what will get achieved and the way it will get achieved. Contractors, alternatively, are self-employed and are impartial of the payer, who can solely management the result of the work, not how it is going to be carried out.

This distinction is important. Employers have substantial authorized obligations to their staff, together with compliance with wage and hour legal guidelines, state and federal revenue tax withholding, cost of unemployment and Social Safety taxes, staff’ compensation, and incapacity, amongst many different labor regulation protections. Usually, impartial contractors are usually not entitled to any of those advantages; all payers must do is pay the contracted fee and concern a 1099 kind. In consequence, classifying a employee as an worker or as a contractor has a big impact on that particular person’s hiring prices.

Numerous employee classification exams

More and more, authorities auditors view misclassification as an unlawful means utilized by firms to improperly scale back labor prices. That will even be true at occasions, however with the workforce more and more fragmented and fractured with the rise of the gig economic system and distant working, figuring out whether or not a employee is certainly an worker or an impartial contractor could not at all times be unlawful, it could be simply laborious.

Over the a long time, courts, authorities companies, and state legislatures have devised many various exams for various contexts in an try to assist decide whether or not a employee qualifies as an worker: the Widespread Legislation Issue Balancing Check; the historic 20-factor take a look at of the IRS; the IRS’s latest three-category take a look at (conduct management, monetary management, relationship sort); the US Division of Labor’s six-factor financial actuality take a look at; the relativity of proof of labor for staff’ wages; and the 12-factor screening entitlement underneath ERISA.

In discussing its three-category take a look at, the IRS web site appropriately cautions: There is no such thing as a magic or set variety of elements that make a employee an worker or an impartial contractor, and no single issue takes this choice. The keys are to have a look at the total report and think about the extent of the proper to direct and supervise the employee ( In different phrases, it’s an evaluation of info and circumstances which requires an in depth and nuanced examination of every particular person scenario.

The rest of this text will concentrate on the ABC take a look at, utilized by some states, together with New Jersey (for wage and hour functions and unemployment insurance coverage), which narrows the evaluation in favor of worker standing and will give sobering entrepreneurs.

The ABC take a look at

Based on the New Jersey ABC take a look at, a employee is assumed to be an worker except the employer can reveal that each one three prongs of the ABC take a look at are met. The three poles are as follows:

  • Such particular person has been and can proceed to be free from management or path within the efficiency of that service, whether or not underneath the SLA or actually;
  • Such service is exterior the conventional course of enterprise for which such service is offered, or such service is offered exterior all of the locations of enterprise of the enterprise for which such service is offered; AND
  • Such a person is ordinarily engaged in an independently established commerce, occupation, career or enterprise. [NJSA 43:21-19(i)(6)(A-C)]

The ABC take a look at purports to be an analogous formulation to the exams talked about above. It seeks to analyze whether or not the employee is free from the payer’s management, the character of the service carried out and whether or not the employee in any other case operates independently. The take a look at is subjunctive, nonetheless, that means that failure of 1 pole confirms that the employee is an worker. Moreover, the burden of proof rests on the get together contesting the classification (usually the employer).

Whereas the ABC take a look at just isn’t new, the New Jersey Division of Labor and Workforce Growth used this take a look at in 2022 to assert two authorized victories within the unemployment insurance coverage enforcement area. The ABC take a look at has been criticized for imposing too excessive a bar on employers, lowering the pliability customary amongst freelancers, and missing enough steerage on its utility. Subsequently, these circumstances, mentioned beneath, deserve cautious consideration.

East Bay Drywall LLC

On August 2, 2022, the New Jersey Supreme Court docket dominated in favor of the federal government, discovering {that a} drywall set up firm, East Bay Drywall, LLC, improperly categorized 16 of its staff as impartial contractors, together with within the circumstances the place a few of these staff had their very own entity, enterprise registration and certificates of insurance coverage. [East Bay Drywall, LLC v. DOL(A-7-21) (085770)(08/02/2022)].

Previous to June 2013, East Bay Drywall was registered with the Division of Labor and Workforce Growth as an employer and reported wages for its staff accordingly. After that date, the corporate stopped reporting wages and started treating its staff as impartial subcontractors, which in 2017 initiated a routine audit from 2013 to 2016. Lots of the subcontractors had been certainly misclassified they usually issued an evaluation of $42,120 in unpaid unemployment taxes and momentary incapacity advantages.

After a number of rounds of appeals, the case reached the New Jersey Supreme Court docket with the remaining points centered on Prong C decoding the impartial apply requirement. In abstract, East Bay Drywall argued that the subcontractors had been obtainable for rent to different contractors; typically they left a job earlier than it was accomplished; they had been free to simply accept or refuse the job; and lots of the staff had fashioned their very own entities and obtained their very own insurance coverage. The courtroom, nonetheless, concluded that based mostly on the ABC take a look at, East Bay Drywall bore the burden of proof and failed to fulfill this burden. Amongst different issues, the courtroom defined that East Bay Drywall failed to offer adequate proof that the employees had been in any other case behaving as impartial companies. For instance, it didn’t current proof exhibiting that staff maintained impartial locations of enterprise, marketed or had their very own staff. Moreover, enterprise registrations and insurance coverage certificates had been inconsistent and several other entities had been in default. In consequence, the courtroom expressed concern that these entities might have been entities in identify solely.

THEEast Bay DrywallThe choice demonstrates the heavy burden employers face when classifying a employee as an impartial contractor in New Jersey underneath the ABC take a look at. It additionally demonstrates the necessity to doc and substantiate info to assist the therapy of impartial contractors and the necessity to have these paperwork in place to mount a profitable audit defence.

Figuring out the right classification of staff could be a difficult and complicated investigation. On the similar time, the enforcement of employee misclassification is gaining traction nationwide.


On September 13, 2022, one month after theEast Bay Drywallchoice, the New Jersey Division of Labor and Workforce Growth issued a press launch saying it had acquired a $100 million cost from Uber Applied sciences, Inc. and its subsidiary after an insurance coverage examine in opposition to unemployment had dominated that the ride-sharing firm improperly categorized 297,866 drivers as impartial contractors for all of 2014 via 2018. The cost consisted of $78 million in overdue contributions, plus $22 million in penalties and curiosity.

Whereas this quantity was, actually, considerably decreased from a proposed preliminary valuation of $523 million, it nonetheless represents the biggest such cost in New Jersey historical past. Whereas there was no public choice on this case, it appears protected to imagine that Uber agreed to pay $100 million as a result of it did not imagine it might affirm the three prongs of the ABC take a look at.

Follow pointers

Figuring out the right classification of staff could be a difficult and complicated investigation. On the similar time, the enforcement of employee misclassification is gaining traction nationwide. New Jersey has made nice strides to step up enforcement, and its efforts look like paying off. In July 2019, New Jersey launched an worker misclassification job power report outlining its intentions. As a part of that report, the Job Power despatched a letter to twenty,000 New Jersey licensed accountants educating them on the misclassification concern. Moreover, in August 2022, New Jersey despatched a employee classification questionnaire to DoorDash drivers associated to its verification of that giant gig economic system employer. It appears possible that New Jersey will enhance a majority of these audits, which can encourage different states to comply with go well with.

CPAs ought to advise enterprise house owners to take inventory of their workforce. How and the place does an organization function? If an organization treats a portion of its workforce as impartial contractors, has it achieved so in a considerate and principled method? Do you could have paperwork to assist your place and your tax therapy? Ought to adjustments be made and, in that case, are measures in place to mitigate publicity? Firms ought to seek the advice of their CPA and different advisors on these points, because the dangers for all industries look like growing.

Corey L. Rosenthal, JD is an govt and chief of state and native tax apply at CohnReznick LLP, New York, NY

Lance E. Rothenberg, JD, LLM is the only proprietor of Rothenberg Tax Legislation.

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