Do you use Independent Contractors?
Make sure they are properly classified under new game changing California Supreme Court decision.
By Sara Boyns – 07.10.18
In April 2018, the California Supreme Court issued a game changing decision for many California businesses that use independent contractors. Historically, in determining whether a worker was an employee or an independent contractor, the Labor Commissioner, Internal Revenue Service, Employment Development Department, and courts applied a multi factor test. Under that test, for the last 29 years the principal factor in determining whether a worker was an independent contractor was “whether the person to whom services is rendered has the right to control the manner and means of accomplishing the result desired.” Other factors were applied to determine if, on balance, a worker was an independent contractor or an employee.
In Dynamex Operations West, Inc. v. Superior Court (Lee), the Supreme Court of California adopted a new standard, the ABC test. Under the ABC test, the hiring entity must prove all of the following in classifying a worker as an independent contractor:
(A) That 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) That the worker performs work that is outside the usual course of the hiring entity’s business.
(C) That the worker is customarily engaged in an independently established trade, occupation, or business.
The hiring entity’s failure to prove any one of these three factors will be sufficient to establish that the worker is an employee, rather than an independent contractor, for purposes of California employment laws. Even if the parties agree to an independent contractor relationship, or the worker prefers to be an independent contractor, under California law the worker will not be an independent contractor unless all 3 factors are proven by the hiring entity.
In adopting the ABC test, the Court explained that all individuals who are reasonably viewed as providing services to a business in a role comparable to that of an employee, rather than in a role comparable to that of a traditional independent contractor, are employees. Workers whose roles are most clearly comparable to those of employees include individuals whose services are provided within the usual course of the business of the entity for which the work is performed and thus who would ordinarily be viewed by others as working in the hiring entity’s business and not as working, instead, in the worker’s own independent business.
Now what do I do? If your business uses independent contractors, you need to evaluate whether the workers will satisfy all of the factors in the ABC test. Many businesses will need to re-classify workers and convert independent contractors to employees. The risk of ignoring this new ABC test and misclassifying workers includes lawsuits by misclassified workers (including potential class actions) for wages, overtime, meal and rest periods, paid sick leave and other employee benefits, and audits and claims for back taxes by the Internal Revenue Service, Franchise Tax Board, and Employment Development Department.
New Department of Labor Regulations Require Analysis
of Exempt Employee Status
By Sara B. Boyns
New regulations issued May 16, 2016 will change the minimum salary requirement for employees to qualify for the executive, administrative, and professional exemption from overtime pay. In California, the current minimum salary for these exempt employees is $41,600. Beginning December 1, 2016, in order to be exempt from overtime, employees in these classifications will need to be paid a minimum of $47,476 per year to remain exempt.
The Fair Labor Standards Act (FLSA) guarantees a minimum wage and overtime pay at a rate of not less than one and one-half times the employee’s regular rate for hours worked over 40 in a workweek. While these protections extend to most workers, the FLSA provides a number of exemptions. In order to be properly classified as exempt, an employee must satisfy tests related to their primary duties, and for some exemptions, they must be paid on a salary basis at not less than a specified minimum amount.
The New Regulations:
On March 13, 2014, President Obama signed a Presidential Memorandum directing the DOL to update the regulations defining which white collar workers are protected by the FLSA’s minimum wage and overtime standards. In 2015, the U.S. Department of Labor proposed a significant increase in the minimum salary that employers must pay employees in order for employees to qualify as exempt from overtime under the FLSA “white collar exemptions.”
The final DOL regulations were published in the Federal Register by May 16, 2016, and they become effective December 1, 2016.
- The Regulations Impose a Significant Increase in the Minimum Salary Requirement
The regulations increase the salary threshold for California employers from $41,600 to $47,476 per year ($913.00 per week.) The new salary requirements apply to employees who qualify as exempt executive, administrative, and professional (EAP) employees. Workers not subject to the EAP salary level test include teachers, academic administrative personnel, physicians, lawyers, judges, and outside sales workers.
Employers may satisfy up to 10 percent of the minimum salary requirement with payment of nondiscretionary bonuses, incentive payments, and commissions, provided these forms of compensation are paid at least quarterly.
White collar employees subject to the salary level test earning less than $913 per week will not qualify for the EAP exemption, and therefore will be eligible for overtime, irrespective of their job duties and responsibilities. Employees earning this amount or more on a salary or fee basis will qualify for exemption only if they meet the standard duties test, which is unchanged by the DOL’s Final Rule. As a result of this increase, the DOL estimates that 4.2 million employees who meet the standard duties test will no longer fall within the EAP exemption and therefore will be eligible for overtime, absent some action by employers.
- The Regulations do not Change the Duties Requirement for Executive, Administrative or Professional Employees.
The final regulations do not change the duties tests for the executive, administrative, and professional exemptions. Under federal law, in addition to meeting the new salary test, exempt employees’ primary duties must meet the following criteria:
- The employee’s primary duty must be managing the enterprise, or managing a customarily recognized department or subdivision of the enterprise; and
- The employee must customarily and regularly direct the work of at least two or more other full-time employees or their equivalent; and
- The employee must have the authority to hire or fire other employees, or the employee’s suggestions and recommendations as to the hiring, firing, advancement, promotion or any other change of status of other employees must be given particular weight.
- The employee’s primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers; and
- The employee’s primary duty includes the exercise of discretion and independent judgment with respect to matters of significance.
- The employee’s primary duty must be the performance of work requiring advanced knowledge, defined as work which is predominantly intellectual in character and which includes work requiring the consistent exercise of discretion and judgment; and
- The advanced knowledge must be in a field of science or learning; and
- The advanced knowledge must be customarily acquired by a prolonged course of specialized intellectual instruction.
The employee’s primary duty must be the performance of work requiring invention, imagination, originality or talent in a recognized field of artistic or creative endeavor.
- The Regulations Provide for Automatic Future Increases of the Minimum Salary Requirements for Executive, Administrative And Professional Employees, And Highly Compensated Employees.
The regulations will automatically update the standard salary level requirement every three years for EAP workers and highly compensated employees. Specifically, the standard salary level for EAP workers will be updated to maintain a threshold equal to the 40th percentile of weekly earnings of full-time salaried workers in the lowest-wage Census Region. The highly compensated employee compensation level will increase every three years to maintain the threshold equal to the 90th percentile of annual earnings of full-time salaried workers nationally.
How Do the Federal Regulations Interact with California’s Minimum Wage Increases?
Currently California requires executive, administrative and professional (“EAP”) employees to earn at least double what they would receive for working forty hours per week at minimum wage, to qualify as exempt. At the current state minimum wage ($10/hr.), that is $800 per week, or $41,600 per year.
California’s minimum wage will rise over the next few years, until it reaches $15 per hour in 2022. As a result, the minimum salary for exempt status of EAP employees will continue to rise. The minimum wage increase has different effective dates for large employers (26 or more employees) and small employers (25 employees or fewer), as follows:
California Employers with 26 or More Employees *Pay the Higher of the State vs. Federal Threshold Annual Salary for Exempt Employees
|California Minimum Wage||$10/hr.||$10/hr.||$10.50/hr.||$11/hr.||$12/hr.||$13/hr.||$14/hr.||$15/hr.|
|California Exempt Employee Threshold
|Federal Exempt Employee Threshold Salary||$23,600||$47,476*||$47,476*||$47,476*||$47,476||?||?||?|
California Employers with Fewer than 26 Employees *Pay the Higher of the State vs. Federal Threshold Annual Salary for Exempt Employees
|California Minimum Wage||$10/hr.||$10/hr.||$10/hr.||$10.50/hr.||$11/hr.||$12/hr.||$13/hr.||$14/hr.||$15/hr.|
|California Exempt Employee Threshold
|Federal Exempt Employee Threshold Salary||$23,600||$47,476*||$47,476*||$47,476*||$47,476*||?||?||?||?|
Practical Impacts of New Regulations
- Millions of exempt employees who are reclassified as hourly, non-exempt employees will need to track all hours worked.
- Commentators observe that the new regulations may not raise overall employee compensation if employers adjust to keep costs level.
For example, if employee #1 is exempt and is currently paid $41,600 per year ($800 per week), instead of raising employee #1’s compensation to $913 per week, an employer may make employee #1 non-exempt and pay employee #1 less than $20. per hour, limit employee #1’s hours to 40 per week, and hire employee #2 to perform any work that employee #1 cannot complete in 40 hours per week.
- Employees will lose flexibility. Currently exempt employees typically don’t track their hours and are free to adjust their work schedule as long as their work is completed. If classified as non-exempt, employees will need to track all hours worked and normally adhere to a more rigid schedule.
- Employers may have to reduce bonuses and fringe benefits, e.g., health insurance contributions, 401(k) match, vacation, or paid sick to adjust for higher employee wage costs.
- Even if benefits are not intentionally reduced as a cost-saving measure, non-exempt employees may accrue fewer benefits under existing employer policies.
- Employee morale issues will occur. Employees who are reclassified as non-exempt may view the change as a demotion or loss in status. Also, employees who currently telecommute may now be non-exempt, and will have to perform their jobs at the employer’s location. Exempt employees who routinely check email and work at home outside of work hours may not be able to continue with this practice because they will have to be paid for all hours worked.
What Employers Should Do NOW to Prepare
- Audit all exempt positions to determine if the positions qualify as exempt. Use this as an opportunity to review ALL exempt positions, not just the executive, administrative and professional exemptions because the new DOL regulations provide employers the opportunity to properly classify any employees who may have been misclassified.
- Rewrite job descriptions, if needed.
- Determine the cost of maintaining those positions as exempt, and the effect on your budget.
- Evaluate and quantify the tasks exempt employees perform on a weekly basis and how many hours they usually work. Then analyze what tasks, if any, can be reassigned or outsourced if employees are routinely working more than 40 hours per week (or 8 hours a day) so you can assess how the work will get done, and who will do it.
- Determine the cost of converting currently exempt employees to non-exempt, and either hire new employees to fill in the gaps, or budget to pay existing employees to get the work done.
- Identify individual employees who will be reclassified.
- Develop a communication plan to explain the reclassification and the effect on employees in your company. Address the employee morale issues that may arise from employees’ perceived loss of status and actual loss of pay.
- Explain the company’s reasons for classifying certain positions as non-exempt instead of just raising salaries. Employees may wonder why a co-worker remained exempt and received a raise when they feel they were demoted and will now make less money doing essentially the same job.
- Train newly classified employees and their managers about timekeeping requirements, meal and rest period laws, recordkeeping, hours worked, restrictions on telecommuting and work from home on email, and prohibit working “off the clock.”
- At least 7 days before the change, California employers will need to give employees the form required by Labor Code 2810.5 to notify them of their change in status and new hourly pay and overtime rate. You can access the form at https://www.dir.ca.gov/dlse/LC_2810.5_Notice.pdf
- Correct any existing classification errors as part of the response to the new regulations to reduce potential liability.
Additional details regarding the new DOL regulations is available at https://www.dol.gov/whd/overtime/final2016/index.htm
Please contact us if you have questions about the new DOL overtime regulations.
Sara Boyns is a lawyer with the Fenton & Keller law firm in Monterey. This article is intended to address topics of general interest, and should not be construed as legal advice. For more information, please visit www.fentonkeller.com
We look forward to assisting you in your efforts to revise your policies and comply with these new laws. If you have any questions about any of the above information, please do not hesitate to contact any member of our employment group, Christopher E. Panetta, Dennis McCarthy, Sara B. Boyns, Sharilyn R. Payne, Elizabeth R. Leitzinger and Christina J. Baggett.