The ABCs of Worker (Mis-)Classification - The CPA Journal

The ABCs of Employee (Mis-)Classification – The CPA Journal

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

Whether or not an worker is correctly characterised and handled as an worker or as an unbiased contractor is a posh however more and more necessary inquiry for enterprise homeowners and their advisors. Spurred by the COVID-19 pandemic, the continued enlargement of the gig economic system in addition to the fast shift to distant work are two components which are drawing elevated consideration to those points.

Federal and state laws range, however enforcement of employee misclassification is changing into a rising precedence for state auditors. In New Jersey, there have been some notable developments, together with the latest $100 million fee by Uber Applied sciences, Inc. to settle an unemployment insurance coverage classification evaluate for staff, the most important such fee in state historical past.

Job Classification Fundamentals

Right classification might be unclear as a result of there are sometimes overlapping however completely different assessments relying on the case (eg, earnings tax, payroll tax, unemployment insurance coverage, wage and hour) and authorities company (eg, tax, labor, federal, state) difficulty , which may result in completely different outcomes. As a common proposition, nonetheless, all classification guidelines study these two sides of the identical coin: 1) the diploma of the employee’s independence from the payer and a couple of) the diploma of the payer’s management over the employee. Staff work for and below the supervision of their employers, who management what can be finished and the way will probably be finished. Nevertheless, contractors are self-employed and have independence from the payer, who can solely management the result of the work, not how will probably be finished.

This distinction is critical. Employers owe important authorized duties to their workers, together with compliance with wage and hour legal guidelines, withholding state and federal earnings taxes, paying unemployment and social safety taxes, and staff’ compensation and incapacity insurance coverage, amongst many different labor legislation protections. Typically talking, unbiased contractors aren’t entitled to any of those advantages; all payers should do is pay the contracted fee and difficulty a Type 1099. Consequently, classifying a employee as an worker or as a contractor has a major impact on the price of using that particular person.

Numerous Employee Classification Checks

Authorities auditors more and more view misclassification as an unlawful means utilized by corporations to improperly cut back their labor prices. Generally that could be true, however with the workforce more and more fragmented and divided with the rise of the gig economic system and telecommuting, figuring out whether or not a employee is really an worker or unbiased contractor might not all the time be unlawful, however it could possibly simply be tough .

Over the many years, the courts, authorities businesses, and state legislatures have created many alternative assessments for various contexts in an try to assist decide whether or not a employee qualifies as an worker: the balancing check for the frequent legislation issue; IRS historic 20-factor check; the IRS’s newer three-category check (behavioral management, monetary management, kind of relationship); the US Division of Labor’s six-factor financial actuality check; the relative nature of the work check for staff’ compensation functions; and the 12-factor proper to regulate check below ERISA.

In discussing its three-category check, the IRS web site aptly warns: There is no such thing as a magic or set variety of components that make the employee an worker or an unbiased contractor, and nobody issue stands alone on this dedication. The keys are to have a look at all the relationship and contemplate the scope of the suitable to direct and management the employee ( In different phrases, it is a facts-and-circumstances evaluation that requires an in depth and nuanced examination of every particular person state of affairs.

The rest of this text will deal with the ABC check utilized by sure states, together with New Jersey (for wage and hour and unemployment insurance coverage functions), which tightens the evaluation in favor of worker standing and will give enterprise homeowners pause.

The ABC check

Underneath New Jersey’s ABC check, a employee is presumed to be an worker until the employer can display that each one three prongs of the ABC check are met. The three legs are as follows:

  • Such particular person has been and can proceed to be free from management or path of the efficiency of such service, each below their service contract and actually;
  • Such service is both exterior the extraordinary course of enterprise for which such service is carried out, or such service is carried out exterior of all locations of enterprise of the enterprise for which such service is carried out; and
  • Such an individual is often engaged in an independently established commerce, enterprise, occupation or enterprise. [NJSA 43:21-19(i)(6)(A-C)]

The ABC check purports to be an identical formulation to the above assessments. It goals to research 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 works independently. Nevertheless, the check is conjunctive, which means {that a} failure confirms that the employee is an worker. Moreover, the get together difficult the classification (usually the employer) has the burden of proof.

Though the ABC check will not be new, the New Jersey Division of Labor and Workforce Growth used this check in 2022 to assert two authorized victories within the unemployment insurance coverage enforcement area. The ABC check has been criticized for imposing extreme calls for on employers, lowering the flexibleness frequent amongst freelancers, in addition to missing enough steering concerning its use. As such, these circumstances, mentioned under, deserve cautious consideration.

East Bay Drywall LLC

On August 2, 2022, the New Jersey Supreme Courtroom dominated in favor of the federal government, discovering {that a} drywall set up firm, East Bay Drywall, LLC, had improperly labeled 16 of its staff as unbiased contractors, even when a few of these staff had their very own machine, their very own enterprise registration and their very own insurance coverage certificates. [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 accordingly for its workers. After that date, the corporate stopped reporting wages and commenced treating its staff as unbiased contractors, which in 2017 triggered a routine audit from 2013 to 2016. The auditor sought proof of every prong of the ABC check for the assorted staff and in the end concluded concluded that a number of of the subcontractors had been truly misclassified and issued an evaluation of $42,120 in unpaid unemployment tax and short-term incapacity advantages.

After a number of rounds of appeals, the case reached the New Jersey Supreme Courtroom, with the remaining points targeted on C-prong’s interpretation of the unbiased enterprise requirement. In abstract, East Bay Drywall argued that the subcontractors had been open to subletting to different contractors; typically they left a job earlier than it was completed; they had been free to simply accept or refuse work; and several other of the employees had shaped their very own models and obtained their very own insurance coverage. Nevertheless, the courtroom concluded that below the ABC check, East Bay Drywall bore the burden of proof and failed to fulfill that burden. The courtroom defined, amongst different issues, that East Bay Drywall didn’t present enough proof that the employees in any other case behaved as unbiased companies. For instance, it failed to offer proof that the employees had unbiased locations of enterprise, marketed or had their very own workers. Moreover, the enterprise registrations and proof of insurance coverage had been inconsistent and several other of the entities had been at fault. Subsequently, the courtroom expressed concern that these entities may have been entities in title solely.

ThatEast Bay DrywallThe choice demonstrates the heavy burden employers face when classifying a employee as an unbiased contractor in New Jersey below the ABC check. It additional demonstrates the need of documenting and substantiating the details supporting the unbiased contractor’s remedy and the necessity to have these paperwork obtainable to make sure a profitable audit protection.

Figuring out correct employee classification generally is a difficult and complicated investigation. On the similar time, employee misclassification enforcement is gaining traction nationally.


On September 13, 2022, one month afterEast Bay Drywallchoice, the New Jersey Division of Labor and Workforce Growth issued a press launch asserting that it had acquired a $100 million fee from Uber Applied sciences, Inc., and its subsidiary, after an unemployment insurance coverage audit decided that the ride-sharing firm had misclassified 297,866 drivers. as unbiased contractors all through 2014 by 2018. The fee consisted of $78 million in overdue contributions, plus $22 million in penalties and curiosity.

Though this quantity was certainly considerably lowered from an initially proposed evaluation of $523 million, it nonetheless represents the most important such fee in New Jersey historical past. Though there was no public choice on this case, it appears protected to imagine that Uber agreed to pay $100 million as a result of they didn’t imagine it may substantiate the three legs of the ABC check.

Apply pointers

Figuring out correct employee classification generally is a difficult and complicated investigation. On the similar time, employee misclassification enforcement is gaining traction nationally. New Jersey has taken steps to extend enforcement, and its efforts seem like paying off. In July 2019, New Jersey issued a Activity Pressure Report on Worker Misclassification outlining its intentions. As a part of this report, the Activity Pressure issued a letter to twenty,000 licensed New Jersey public accountants educating them on the difficulty of misclassification. Moreover, in August 2022, New Jersey issued a employee classification questionnaire to DoorDash drivers in reference to their audit of the massive gig economic system employer. It appears probably that New Jersey will enhance a lot of these audits, which may encourage different states to observe go well with.

CPAs ought to advise enterprise homeowners to take inventory of their workforce. How and the place does an organization function? If an organization treats a portion of its workforce as unbiased contractors, has it finished so in a considerate and principled means? Does it have data to assist its place and tax remedy? Ought to adjustments be made and, in that case, ought to steps be taken to cut back publicity? Corporations ought to seek the advice of with their CPA and different advisors on these points, as the danger for all industries seems to be growing.

Corey L. Rosenthal, JD is a principal and head of the state and native tax observe at CohnReznick LLP, New York, NY

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

Author: ZeroToHero

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