The California Supreme Court has raised the bar for companies classifying workers as independent contractors instead of employees.
The decision, in a case against Dynamex Operations West, could have far-reaching consequences for companies like Uber and Lyft, but also for millions of workers.
The decision broke little new ground, but it served notice to businesses that they would have to strictly meet the standards that separate an employee from an independent contractor. To be an independent contractor, a worker must be free from the company's control and direction in the way they perform a task.
As an example, the court said a company hiring a plumber to repair a leak is hiring an independent contractor. But hiring a seamstress who works at home is hiring an employee.
"Although in some circumstances classification as an independent contractor may be advantageous to workers as well as to businesses, the risk that workers who should be treated as employees may be improperly misclassified as independent contractors is significant in light of the potentially substantial economic incentives that a business may have in mischaracterizing some workers as independent contractors," the justices wrote.
For example, employees pay half of their Social Security/Medicare tax while the employer pays the other half. If the worker is classified as an independent contract, the contractor pays the full amount. There are other costs associated with employees that a business doesn't face when the work is performed by an independent contractor.
The court held that the businesses that misclassify employees as contractors gain an unfair competitive advantage over competitors that strictly follow the rules.
Threatens the gig economy
The ruling threatens to send shock waves through the so-called "gig economy," which grew in the years following the Great Recession. Businesses that were forced to lay off thousands of employees were slow to rehire, finding they could fill needs with temporary workers and independent contractors, who performed jobs for more than one company.
Ridesharing apps Uber and Lyft adopted that model, with drivers using their own vehicles and setting their own hours. It remains to be seen exactly how the court ruling affects these companies and their drivers. Legal experts agree, however, that businesses must be able to prove that an independent contractor is actually running his or her own business.
The Internal Revenue Service (IRS) has noted that telling an employee from an independent contractor is not always easy, saying it often depends on the facts in each case. In the case the California court decided, Dynamex Operations West had previously classified its drivers as employees, but it changed them to independent contractors in 2004 without changing their duties.
"The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done," the agency says on its website.
The IRS says the critical factor is whether the employer "has the legal right to control of how the services are performed."