If you’re a recruiting agency owner who makes contract placements and runs your own back office to do so, there’s a good chance that you’re classifying the contract candidates that you place as independent contractors.
Your ability to do so may be running out. This is especially the case if you operate a recruiting business in certain states.
One of those states is California, and what happened recently in The Golden State will more than likely have far-reaching implications throughout the rest of the country.
Earlier this year, the California Supreme Court issued a ruling that makes it more difficult for employers to classify their workers as independent contractors. The ruling was the result of a class-action lawsuit against Dynamex Operations West, a package and document delivery company (Dynamex Operations West, Inc. v. Superior Court).
The class-action suit charged that Dynamex misclassified its delivery drivers as independent contractors as opposed to W-2 employees. The California Supreme Court ruling agreed that Dynamex had misclassified its delivery drivers.
What does that mean? A lot of things, including penalties, fees, and fines for misclassification of workers.
It also means that this ruling does not begin and end with businesses such as Dynamex, Uber, and Lyft. It also extends to recruiting firms that place contractors at their client companies and classify those placed candidates as independent contractors and not W-2 employees.
And THAT means recruiting firm owners who are running their own back office and misclassifying workers are also at risk for incurring penalties, fees, and fines.
The ABC Test and classifying workers
Let’s look at some of the questions you may have regarding this issue.
#1—What are the specifics of this ruling?
What is going to determine if you are, indeed, misclassifying your contract workers? The California Supreme Court decreed that the “ABC Test” should be used to determine correct classification. That test is spelled out as follows:
(A) The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
(B) The worker performs work that is outside the usual course of the hiring entity’s business.
(C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
So this means that if a worker can not pass all three aspects of the “ABC Rule,” they should be classified as a W-2 employee and NOT as an independent contractor.
#2—But I don’t operate my recruiting agency in California, so what do I have to worry about?
The fact of the matter is that this is a rapidly growing trend in the world of employment. More states are addressing it with each passing year, so it’s only a matter of time before your state legislation joins the crowd. There are currently two other states that restrict the ability of employers to call workers independent contractors. Those states are Massachusetts and New Jersey.
However, there are other states that are currently addressing this issue in other ways. Although they may not be taking as hard of a stance as California, Massachusetts, and New Jersey, they are taking a stance. Those states include Colorado, Connecticut, Delaware, Illinois, Maine, Minnesota, Montana, New York, North Dakota, Pennsylvania, and Wisconsin.
If you operate a recruiting agency in one of these states, do you know what your state’s stance is regarding the classification of workers? If not, this would be the opportune time to find out.
#3—What’s behind this ruling, anyway? What’s driving it?
There are a couple of factors driving the trend to classify workers correctly. The one that is possibly the biggest (and the one that receives the most publicity) is the protection of workers. Independent contractors are not afforded the same luxuries as W-2 employees . . . starting with the fact they don’t have access to benefits like health insurance. But it doesn’t stop there. Independent contractors also don’t have access to Workers’ Compensation or unemployment insurance and they’re required to pay more in taxes for the work they do than if they were an organization’s W-2 employee.
Which brings us to the second reason: money. When employers classify workers as independent contractors, states are losing out on money. They make more money on a W-2 employee than they do on an independent contractor. So let’s check this out. Are any of the states mentioned above experiencing fiscal difficulty? Well . . .
The Mercatus Center of George Mason University ranks the states by fiscal condition on an annual basis. The Center assigns an overall “grade” to each state. Those grades are as follows:
- Top Five
- Above Average
- Average
- Below Average
- Bottom Five
Where do California, Massachusetts, and New Jersey rank, since those are the states that are taking the hardest stance against worker misclassification?
Let’s start with the fact that New Jersey ranked dead-last in the Mercatus Center Study. That’s right: #50. Massachusetts was also in the bottom five at #48. California was not much better, sitting “Below Average” at #43. Could it be that these states, which appear to be in dire need of more funds, are trying to make sure that they maximize the amount of money they receive through the employment of workers?
One would have to agree that this is at least a fair question to ask, in light of the information presented.
But what about the other states mentioned above? North Dakota is in the “Top Five”; Montana is “Above Average’; and Colorado, Delaware, Minnesota, and Wisconsin are all “Average.” All other states were “Below Average,” and in fact, Illinois joined New Jersey in the “Bottom Five.” Illinois, which seems to endure a budget crisis every year, claimed the 49th position.
#4—This ruling mainly affects companies whose business model revolves around independent contractor-style work, right, companies like Uber and Lyft?
This ruling affects ANY business owner who is misclassifying their workers. This includes recruiting firm owners who are misclassifying their contract workers. Such owners are every bit at risk as are large companies like Uber and Lyft.
It would be a mistake to assume that just because you work in the recruiting and staffing industry that you are somehow insulated from the implications of this ruling. If you conduct business in the state of California, there is no insulation from the implications of this ruling. The California Supreme Court has made it crystal-clear what constitutes correct classification of workers and what constitutes misclassification of workers. And when there is misclassification, there will also be penalties, fees, and fines.
#5—What if the worker requests that they be classified as an independent contractor?
Their request has no bearing on how they are classified. The “ABC Rule” ultimately determines classification, not the request of the worker or the whims of the employer. In the Dynamex ruling, the California Supreme Court ruled that the intent of public policy in protecting workers is a central consideration in determining how those workers should be classified.
In other words, California is making it a priority to protect workers as much as possible . . . even if that means protecting those workers from themselves.
#6—What kind of penalties, fees, and fines are we talking about there?
It’s not just the amount that’s alarming, but it’s also the number. That’s because they could come from both state and federal agencies. Although we haven’t mentioned the Internal Revenue Service yet, that doesn’t mean that the IRS has no stake in this matter. After all, Fed Ex settled a misclassification case three years ago, paying over $200 million in fines to a number of agencies. And yes, one of them was the IRS.
However, all of that isn’t even the most disturbing part of the answer to this question. The most troubling part deals with the retroactive application of penalties, fees, and fines. What the heck does that mean? It means that not only will you be fined for the act of misclassifying workers, but you’ll be fined retroactively, as well. That’s like being fined multiple times for what—in your mind, at least—is one infraction. Let that sink in for a minute. That’s the kind of scenario that could sink your business.
Employers in California, as you might imagine, are maintaining that a retroactive application will constitute a violation of due process. So there’s a possibility that at the very least, there will be a limit to the extent that penalties, fines, and fees are assessed to employers who are found guilty of misclassifying workers. But in the end, that might end up being a small consolation, if one at all, to those particular employers.
#7—What does the future hold regarding this issue?
It’s been said that the best way to predict the future is to study the past. If we take that approach with this particular issue, we can make the following predictions:
More states are going to start addressing the issue of worker misclassification.
That has been the trends, and that will continue to be the trend. The reasons are simple. Laws that protect the rights of workers are extremely popular with the public, and the public casts votes. They decide who gets elected and who does not, and that is something in which politicians are quite interested. That’s the “protect the worker” side of the misclassification coin. What about the “money” side of that same coin?
The same logic applies. There are quite a few state governments that are hurting for money right now. What happens if California, New Jersey, or Massachusetts start to increase their revenues simply by making sure that employers are properly classifying their workers? That’s right: other states are going to start addressing the issue, anticipating that they can fill their coffers in much the same way.
The states that are already addressing the issue are going to continue to address it and more than likely harden their stance regarding it.
Before taking its current hard-line stance on worker misclassification, California’s previous stances could be considered softer. The state has been moving in the direction punctuated by the Dynamex ruling by degrees. It didn’t turn the dial from zero to 100 in a single day. That’s also been the case with Massachusetts and New Jersey.
More than likely, the states that have already started addressing this issue, but not to the degree that those three have, will eventually reach the same place that those three are. In fact, you might even assume that every state will eventually be where California is—with a court ruling that makes the “ABC Rule” the law of the land when it comes to the classification of workers.
#8—What can I do if I’ve been misclassifying my contract candidates?
The good news is that there are options. One of them is to start classifying workers correctly by applying the “ABC Rule” to all of the candidates that you place on a contract basis. However, that might cause more problems than it solves if your business is not set up to be a W-2 Employer of Record. When you classify workers as employees and not independent contractors, that means you become the W-2 Employer of Record. It’s another way of saying that your firm is the legal employer.
However, as you might be well aware, there are all sorts of paperwork that accompanies becoming the legal employer. (Which might very well have been the reason that you were classifying your contract candidates as independent contractors in the first place.)
The ABC Test and options for recruiters
Another, more palatable options, would be to outsource the W-2 Employer of Record duties to a back office service provider. That way, the back office assumes all of the legal, financial, and administrative responsibilities associated with employing the contractors. In other words, they are responsible for being compliant and you are not. You don’t have to worry about legal liability. All you have to do is worry about cashing placement checks. And that’s a lot more fun than battling your state legislation, the Internal Revenue Service, and everybody in between.
Top Echelon Contracting has served as a back office solution for the recruiting and staffing industry since 1992. We can become the W-2 Employer of Record for your contract candidates, assume the responsibility and liability as the legal employer, and allow you to focus more on what you do best—recruiting.
Click here to schedule a time to speak with a specialist and find out how Top Echelon Contracting can relieve you of the burden of being the Employer of Record.
The Dynamex court decision is just one in a long series of events that proves the issue of worker misclassification is not going away. Not only that, but it’s only going in one direction: where an increasing number of workers are classified as W-2 employees and NOT as independent contractors
For more information, visit www.topechelon.com/contract-staffing or call 888.627.3678.