Court Holds Dynamex ABC Test Does Not Apply for Unemployment Insurance Purposes Pre-2020, but Employer Still Loses BY: ROBERT HORWITZ and TENZING TUNDEN
In September 2019, California enacted Assembly Bill 5, which codified the three part “ABC test” of Dynamex Operations West Inc. v. Superior Court, 4 Cal.4th 903 (2018), to determine whether workers are employees and not independent contractors. Under the ABC test a worker is presumed to be a common law employee unless the hiring entity can establish three factors:
- The individual is free from the control and direction of the hiring entity in connection with the performance of work;
- The individual performs work that is outside the usual course of the hiring entity’s business; and
- The individual is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.
The California Court of Appeal in Vendor Surveillance Corporation v. Patrick W. Henning Jr., 2021 WL 1034833 (2021), declared that, except with respect to wage orders, the “ABC” test does not apply for years before 2020. Instead, the eleven-factor test of S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989), applies to determine whether workers were employees or independent contractors. These factors are also set out in an EDD regulation, California Code of Regulations, Title 22, § 4304-1.
The most important of the Borello factors is the right to control the manner and means of accomplishing the result desired. Other factors are:
- Whether the one performing services is engaged in a distinct occupation or business;
- The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;
- The skill required in the particular occupation;
- Whether the principal or the workman supplies the instrumentalities, tools, and the place of work;
- The length of time for which the services are to be performed;
- The method of payment, whether by the time or by the job;
- Whether the work is a part of the regular business of the principal; and
- Whether the parties believe they are creating the relationship of employer-employee
In Vendor Surveillance Corporation, the California Employment Development Department (EDD) audited Vendor Surveillance Corporation (“VSC”) for tax years 2011 through 2013. VSC maintained a database of project specialists who are qualified to perform source inspections of manufacturing operations to ensure no defective parts escape detection and are installed in an aircraft. VSC classified its project specialists as independent contractors and engaged them under an “Independent Contractor Agreement.” Since it treated them as independent contractors, VSC did not pay unemployment insurance tax on the earnings of the project specialists.
In the audit, the EDD determined that VSC misclassified project specialists and that VSC’s project specialists were common law employees under Unemployment Insurance Code section 621 and regulation 4304-1 (Borello factors). The EDD assessed VSC $1,046,578.35 for unemployment insurance, state disability insurance, and personal income tax, plus approximately $48,000 in interest. After VSC’s administrative challenges, EDD reduced the assessment to $278,692.45. VSC paid the tax and sued for a refund.
In the refund suit in the superior court, the EDD argued that Dynamex’s ABC test applied retroactively to the unemployment insurance assessments for tax years 2011 through 2013. VSC maintained that Borello applied. The superior court applied both tests and held that the project specialists were independent contractors. VSC appealed.
The two issues before the California Court of Appeal were (1) for purposes of assessing unemployment insurance tax, what is the appropriate test for determining whether a worker was an employee or independent contractor for work performed during that period; and (2) did the trial court correctly apply the appropriate test in reaching its decision. VSC argued that as a matter of law, Borello applies in determining liability for unemployment insurance tax for work performed during the audit years and that its due process rights would be violated by applying Dynamex retroactively. The Court of Appeals agreed with that Borello applies, making it unnecessary to consider the second. The Court of Appeals held that the superior court’s determination under the Borello factors was supported by substantial evidence. Thus, it affirmed the superior court’s ruling that the project specialists were employees and that VSC was not entitled to a refund. Despite the loss to the taxpayer, this decision will help guide taxpayers and the EDD during audit of tax periods ending before January 1, 2020, and makes it clear that the more stringent ABC test will not apply in determining worker classifications.
Robert S. Horwitz is a Principal at Hochman Salkin Toscher & Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division. He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.
Tenzing Tunden is a Tax Associate at Hochman Salkin Toscher Perez P.C.