Expanding “Gig Economy” Redefining Employee Classification

Eli Noff, Esq., Partner
Mary F. Lundstedt, Esq., Associate

Both federal and state government agencies are increasingly scrutinizing the distinction between an employee and an independent contractor. On November 14, 2019, Bloomberg law reported that New Jersey's Department of Labor and Workforce Development (NJ Labor Department) has informed Uber Technologies Inc. and subsidiary Rasier LLC (collectively, "Uber") that they owe approximately $650 million in unemployment and disability insurance back taxes, penalties and interest. The NJ Labor Department believes that the rideshare companies have been incorrectly classifying drivers as independent contractors. This latest development should remind employers to be mindful of the distinctions between these classifications, even amongst state agencies.

IRS Approach

Considering the stakes involved, correctly establishing employment status of workers is crucial. The result dictates whether the service recipient will need to deal with employment tax and income withholding, deposit, and reporting obligations. It also has implications, including but not limited to, regarding benefit coverage, wage claims, insurance, and compliance with employment laws and ordinances.

The Internal Revenue Service (IRS) defines a common-law employee in terms of the ability to control performance. In other words, generally, an employer-employee relationship:

exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished.[1]

Obviously, such determination requires examination of the facts and circumstances of each case. The IRS has provided 20 common law factors to aid in making this determination-but the IRS has emphasized that these are not the only important factors.[2]

Notable State Developments

Misclassifications have been the subject of numerous lawsuits, particularly in the transportation and technology industries. With the rise of the "gig economy," misclassification litigation is trending. We will briefly consider a few of the more notable developments, below.

For instance, in 2016, an Uber driver filed suit in North Carolina, claiming misclassification as an independent contractor rather than as an employee. In 2017, the court granted a class certification which resulted in approximately 5,200 drivers opting in. Although the court in Hood v. Uber Techs., Inc.[3] ultimately didn't issue a final determination as to whether the drivers involved in the class action suit were misclassified, the parties settled resulting in $1.3 million dollars owed to the drivers.

Subsequently, in Dynamex Operations West Inc. v. Superior Court of Los Angeles,[4] a unanimous court in California introduced a new three-factor test to apply when determining classification. The case did not involve Uber drivers; rather it considers the classification of a company's delivery drivers.

The new test in California is based on a presumption that all workers are employees. The burden now is on the entity to show otherwise. The new test is commonly referred to as the "ABC" test, and indicates that a worker is an independent contractor if the hiring entity establishes the worker:

  • is free from the control and direction of the hiring entity in connection with the work performance (both under the contract for the work performance and in fact);
  • performs work that is outside the usual course of the hirer's business; and
  • is customarily engaged in an independently established trade, occupation, or business-similar in nature to the work performed for the hirer.

While Uber wasn't the subject of litigation resulting in California's new test, Bloomberg Law reports that Uber and Lyft have both pledged $30 million each to fight the new law.

And finally, the most recent attack on the "gig economy" is the NJ Labor Department assessment that a huge amount of taxes, penalties and interest are owed as a result of Uber's misclassification of drivers. Bloomberg Law reports that:

The state's determination is limited to unemployment and disability insurance, but it could also mean that Uber is required to pay drivers minimum wages and overtime under state law. Uber's costs per driver, and those of Lyft, could jump by more than 20% if they are forced to reclassify workers as employees, according to Bloomberg Intelligence.

Voluntary Classification Settlement Program

The Voluntary Classification Settlement Program (VCSP) is an optional program offered by the IRS, which enables qualified taxpayers to voluntarily reclassify service providers as employees in future tax periods for federal employment tax purposes and provides limited federal employment tax liability for previous independent contractor misclassification.[5]

The VCSP applies to those taxpayers classifying service providers as independent contractors, or other non-employees, that want to prospectively reclassify them as employees. A taxpayer is eligible for the program if (1) the taxpayer consistently treated the workers as non-employees, and (2) filed all required Forms 1099 for the service providers for the previous three years.

Additionally, the taxpayer cannot currently be under IRS audit, nor can the taxpayer be currently under audit concerning the service providers' classification by the Department of Labor (DOL) or by a state government agency. Note that a taxpayer who was previously audited by the IRS or the DOL regarding service provider classification will only be eligible if the taxpayer has complied with the audit's results and is not currently contesting the classification in court.

Conclusion

Employers frequently misclassify their employees as independent contractors. The expanding "gig economy" is rapidly changing the applicable standards and rules. Taxpayers are well-advised to consult a tax professional for guidance on classifying their service providers, especially if they are concerned that they have been misclassifying employees and need to take corrective action which mitigates financial exposure for past liabilities.

If you have questions or concerns regarding employee versus independent contractor classification, call Frost & Associates, LLC today at 410-497-5947.


1 Reg. §31.3121(d)-1(c)(2).

2 Rev. Rul. 87-41, 1987-1 C.B. 296. Independent Contractor or Employee? Training Materials, IRS Training Course 3320-102, TPDS 842381 (Mar. 4, 1997).

3 No. 1:16-CV-998 (M.D.N.C. May 17, 2017).

4 No. S222732 (Cal. Sup. Ct. Apr. 30, 2018).

5 Announcement 2012-45, modifying and superseding Announcement 2011-64.

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