There’s a lot of confusion about the worker misclassification laws, especially since each state uses different tests or variations on tests. Here’s a primer on some of the involved issues in classifying employees and independent contractors.
What is an independent contractor?
The IRS recognizes two classifications of worker: employees and self-employed individuals. Independent Contractors (ICs) fall into that second category. ICs offer their services to their customers on a freelance or contract basis. They typically operate as a sole proprietorship (or, in lay language, “a one person-owned business”) but can also operate an LLC (limited liability company) or corporation. ICs pay taxes on the income they earn from their customers, including federal income tax, state income tax, and a special Self Employment (SE) tax which is their contribution to Social Security and Medicare. Independent Contractors are responsible for their own benefits and insurance policies, including business and health insurance.
Isn’t it good to be an employee and get benefits? Why would someone want to be an independent contractor rather than an employee?
Employment has advantages. but many independent contractors have good reasons for remaining independent. These include:
Flexibility: As an independent contractor, you have the right to accept the assignments you want and turn down those you don’t want. An employee may not have that option. You have the right to negotiate deadlines and fees
Copyright: As an independent contractor, you legally own the copyright to your work. You can negotiate to sell or assign that copyright to your clients as part of your contract. But as an employee, the employer owns the copyright, unless you are able to negotiate that they will assign it to you.
Deductions: As an employee, you cannot deduct your business expenses. Home office, telephone, equipment - that’s not deductible.
Retirement account: As a freelance writer, you likely have multiple clients. Imagine instead, you are a W2 employee of multiple clients. Likely you are not able to get into their retirement plan, if working part time. Instead of contributing up to $19,500 plus 20-25% company profit sharing to a solo 401k, or up to $57,000 in SEP IRA savings in 2020, you would only be able to contribute the IRA limit of $6,000-7,000. (This is not tax or financial advice – please consult with a professional about your specific situation).
Benefits: Getting healthcare, paid time off and other insurance is great, but as a part time employee, how many benefits would you actually get? If you lose your job, can you actually collect for unemployment income if you have other part time jobs? If you get carpal tunnel syndrome and want to file for worker’s comp, how will the multiple insurance companies decide whose policy is responsible?
There are countless other reasons people choose to be an independent contractor rather than an employee.
What is the ABC test?
The ABC test is a holdover from the 1930s, before the internet, before the gig economy. It is a test used to differentiate an employee from an independent contractor. There are different versions of the test. Typically, the individual must answer YES to all three prongs to be an independent contractor.
(A) the individual is free from control and direction in connection with the performance of the service, both under the contract for the performance of service and in fact, AND
Explanation: Prong A is about “control,” as determined by the Department of Labor. Following deadlines and assignment specifications is not necessarily a control issue, but if you’re using the client’s equipment and the client is demanding you do the work at certain times and in certain steps, that could be a problem in saying “yes” to this prong.
(B) the service is performed outside the usual course of the business of the employer or the service is performed outside of all the places of business of the enterprise for which the service is performed; AND
Explanation: This is the prong most problematic for writers. California AB5 and the PRO Act only include the first part of this prong: “the service is performed outside the usual course of the business of the employer.” This first part means that if your role is outside of the client’s course of business, you can say “yes” to this prong. For example, if you write web copy for a law firm, you pass this prong. If you write an article for a publisher to put in their magazine, you may fail this prong. The second part of the B prong means that you cannot work in the client’s office or any place they do business.
(C) the individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed
Explanation: Prong C refers to whether your business has more than one client for whom you do this work. If you are writing for multiple publications, you should be able to say “yes” to the B prong. If you would lose all income if the client cancelled your contract, because you are reliant on one client for your income, you could be in violation of the C prong. Another interpretation is whether you are doing work different from your usual profession. So, if you’re a writer and you go on the speaker circuit to talk about something unrelated, the speaking gigs could be considered a violation of the C prong.
What about this 35-article limit?
California’s AB5 uses the more restrictive version of the B prong of the ABC test, which means that journalists writing articles for newspapers, magazines and some websites, would have to be hired as employees. To allow journalists to continue some freelance work, the California legislation initially gave journalists an exemption to write 35 “submissions” per year per client, before they must become a W2 employee. The passage of AB2257 in September 2020 eliminated that 35-submission cap. This exemption was unique to California. It is not part of the ABC rule in most other states and is not included in the federal PRO Act.
The PRO Act is just about labor, so how does that affect me?
The PRO Act was initially just about organizing and labor unions. However later in the year, legislators added the California version of the ABC test. This would be the first federal law making the ABC test law to determine employment classification rather than other methods (see below). The US Chamber of Commerce says this about the PRO Act: “The PRO Act would impose on the full country California’s stringent definition of ‘independent contractor‘ — denying individuals the ability to work independently, threatening the emerging ’gig‘ economy, and taking away the flexibility that has allowed American businesses of all sizes to grow.”
If Congress passes the PRO Act as is, and the president signs it, will I immediately lose all my work?
That’s not clear. While the ABC test in the PRO Act aims to classify workers as employees for the ability to organize, “it’s another step closer for the ABC test to become a part in the country’s workplace law dynamics” according to a legal analysis.
If my business is an LLC, S-Corp or Sole Proprietorship, this legislation won’t affect me, right?
The legislation doesn’t specify what business entity you must have to be exempt from the legislation. For example, even though California legislators have said that sole proprietors can be considered businesses for purposes of AB5, some contracting companies are telling independent contractors they must be LLCs or corporations. Other companies have stopped using independent contractors even if those contractors are established as a business entity. In other states, legislation also doesn’t define what business entities are exempt. This may be in part to prevent truly misclassified workers from being forced to form an LLC or incorporate so that the company can continue to misclassify them.
Is there other wording legislators can use?
Proposals include not mandating all prongs of the ABC test, changing the wording of the ABC test, or using the IRS Common Law Test. Other countries have an additional category, someone that is not fully an independent contractor and not fully a W2 employee.
Articles about the ABC test:
Welcome to Ms. Kavin’s Neighborhood: Today’s Lesson - the ABCs: https://m.dailykos.com/stories/2020/1/29/1914395/-Welcome-to-Ms-Kavin-s-Neighborhood-Today-s-Lesson-The-ABCs
The Balance Small Business: https://www.thebalancesmb.com/what-is-the-abc-test-for-independent-contractors-4586615
Video series about the ABC test: https://fightforfreelancers.com/videos/