ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – NEW EDD AUDIT GUIDELINES FOR 2022 AND BEYOND – PART 3 – LOOKING AT THE “B & C” ELEMENTS OF THE ABC TEST
By Robert S. Schriebman
A wise person once observed that the only thing certain is this life is change. We see change in virtually everything and everywhere we look. This maxim has never been more accurate when applied to matters of taxation. The treasuries of both the Federal government and the State of California have taken heavy hits since the pandemic began. Governments are looking for money and are directing their taxing agencies to be more aggressive in both the assessment and collection processes.
We will be seeing a more aggressive EDD when it comes to reclassifying independent contractors as common law employees. A big factor in this effort will be the applications of both AB-5 and AB-2257 for the audit years 2021 and beyond. The EDD, due to the pandemic, did not conduct audits in 2020, however, audits that began in 2021 have included the tax year 2020 when issuing assessments. EDD auditors have returned to their desks and their primary jobs as auditors. They have to deal with changes brought about by the Dynamex case and the focus of the new ABC Test that will be used to determine worker status for the future.
This series of articles will review the current and future impact of the ABC Test which grew out of the Dynamex case and was codified in both AB-5 and AB-2257. In this Part 3 we will look at Parts B and C of the ABC Test, the existence of a true independent business owned and operated by the service provider.
The ABC Test in a Nutshell
In a nutshell the ABC Test can be explained as follows:
A worker may be treated as an independent contractor when all of the ABC Test is met.
- The person 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.
- The person performs work that is outside the usual course of the hiring entity’s business.
- The person is customarily engaged in an independently established trade, occupation, or business or the same nature as that involved in the work performed.
The B Test
The essence of the “B” Test is whether the service provider is performing work that is outside the usual business of the employer? The California Supreme Court in Dynamex set the standard as follows: “Contracted workers who provide services in a role comparable to that of existing employees will likely be viewed as working in the usual course of the hiring entity’s business.”
In commenting on the Court’s standard, the EDD provided a couple of test-samples they will be using as their own guidelines as examples of independent contractors:
- A retail store that hires an outside plumber to repair a leak in the bathroom.
- A retail store that hires an electrician to install a new electrical line.
The EDD also provided a couple of examples of what it considers an employer-employee relationship:
- A clothing manufacturer hiring work-at-home seamstresses to make dresses from fabric and patterns supplied by the company.
- A baker hiring cake decorators to work on a regular basis for custom-designed cakes.
The standard set forth in Dynamex and the examples given by the EDD above provide nothing new under the sun. Historically, one of the 23 factors used by the EDD to define an employer-employee relationship is the factor of “integration.” If the individual’s services are so integrated into an employer’s operation that the success or continuation of the business depends upon the performance of the services in question, an employer-employee exists.
Wise business persons do not waste money. Virtually everything they pay for is, in one way or another, essential to the successful operation of the business. Of all the 23 factors in the EDD’s arsenal, this is perhaps the most powerful factor next to the factor of control to show an employer-employee relationship.
The B Test, as described in Dynamex, is going to have to be balanced against § 2776 of AB-2257, the business-to-business contractual relationship. Only time will tell how this will begin to take shape.
The C Test
This test requires the production of evidence proving the service provider has an independently owned and established business. In discussing this test, the Court in Dynamex set the following standards:
- The hiring entity must prove the independent business operation is actually in existence at the time the work is performed. The fact that the business operation could come into existence in the future is not sufficient.
- An individual who independently has made the decision to go into business generally takes the usual steps to establish and promote that independent business.
How does one prove that he/she has established and operates an independent business? This is an important question in light of § 2776 of AB-2257, the business-to-business contractual relationship. There are many things you can do to prove independence, such as, a DBA, business license, incorporation or LLC, and the securing of an EIN from the IRS. Future EDD audits will demand this documentary proof if one wishes to show independence. What is a bit silly about the Court’s standard is requiring the hiring agency to prove this independence. Outside of general contractors requiring subs to be licensed, one usually does not demand this type of proof when hiring outside services.
We have discussed each element of the ABC Test. The next article will discuss the elements in the Borello case decided 1989 because even if you meet all the elements of the ABC Test you still must jump over the Borello hurdle.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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