Just days after Uber tentatively settled a lawsuit in California and Massachusetts for $100 million, another lawsuit was filed in Illinois. This suit, filed on May 2, once again raises the age-old (or at least year-old) question whether Uber could survive if its drivers were classified as employees rather than independent contractors. While it is unlikely that a federal court judge would prospectively require Uber to classify its drivers as employees, the court could decide that drivers had been misclassified and require Uber to pay back overtime pay, benefits, and other expenses.
If that is the outcome, the IRS and state departments of revenue could be champing at the bit to collect the extra funds. The IRS has long been aware that large amounts of potential tax revenue were going unpaid because of the misclassification of workers as independent contractors rather than W-2 employees. During the most recent recession, state departments of revenue also began to pay more attention to worker misclassification.
If a worker is classified as an independent contractor, the employer files a Form 1099 at the end of the year and does not withhold taxes from the worker's paycheck. This means the employer avoids federal and state tax withholdings, payments for the FICA taxes, the employer's matching share of Social Security and Medicare taxes, state and federal unemployment insurance premiums, state disability insurance premiums, workers' compensation costs, and other benefits.
The IRS evaluation for determining whether a worker is an independent contractor or employee is a 20-criteria test. The test has been termed the "right-to-control test" because it focuses on who controls the work being performed. The test follows other IRS rules and the common law concept that an independent contractor should control the manner and means by which the service is provided or the product produced. The more aspects of the relationship that are controlled by the employer, the more likely that the worker is an employee and not an independent contractor.
Another analysis used to determine the presence of an employee relationship is the ABC test, which is similar to the common law test used by the IRS and is the one used by many states. The three factors of the ABC test are:
- whether the individual has been, and will continue to be, free from control or direction over the performance of his or her services; and
- whether the service being provided is outside the usual course of business for the enterprise for which the service is performed or the service is performed outside all the places of business for the enterprise for which the service is being performed; and
- whether the individual is customarily engaged in an independently established trade, occupation, profession, or business.
Unless an employer can prove that all three factors have been met, the worker will be presumed to be an employee and not an independent contractor.
In addition to the federal focus on worker misclassification, an increasing number of states have been examining the issue. Several states have created task forces or committees to quantify various aspects of worker misclassification or have passed legislation aimed at preventing worker misclassification.
But despite the potential downside, Uber may find itself between a rock and a hard place. It can often be difficult for employers to persuade prospective employees to accept employment. It is the individuals themselves who prefer jobs as independent contractors. In most cases, independent contractors are paid a higher hourly rate to offset the fact that they don't receive benefits. If qualified individuals won't accept employment, the employer is left with a difficult decision. But ultimately, misclassifying workers, or even coming close, is a risky proposition.