California Dreaming*

California Dreaming

Californians for the last several decades have dreamed of making their State an American Utopia. And California’s governments accordingly have taken actions intended to help its citizens realize those Utopian dreams. The steps taken by government action and ballot-box referenda have shaped a complex layering of laws, rules and regulations intended to improve the lives of citizens …, and at the same time also created a level of complexity that many see as intrusive and paternalistic, with some labeling it as “creeping socialism.” Adding further complexity would be bad counterproductive unless the benefits of new laws, rules and regulations would serve to realize Californians’ Utopian dreams … and outweigh their burdens.

California’s progressive governments have focused on providing their citizens with greater and greater protections, often rejecting laissez-faire capitalism believing that laissez-faire capitalism often requires a guiding hand to ensure that those without economic power are not cheated disadvantaged by those having power, and that government is best-positioned to make those determinations … and also is the best judge of how to balance the benefits of lawmaking against its burdens. California accordingly has enacted laws that protect immigrants, migrant workers, renters, seniors, consumers, personal information, pollution, etc. … and starting January 1, 2020, selected workers in the gig economy. The problem with enacting laws, even with the very best of intentions, is that they have adverse effects on a portion of the electorate – and those effects often rebound to adversely impact a majority –, distort economics in a variety of predictable and unpredictable ways, and therefore have unintended consequences.

California Governor Gavin Newsom on September 18th signed such a law. Section 2750 adopts a three-part test to determine whether a worker may be classified as an “independent contractor” instead of as an “employee.” All three parts of Section 2750 must be satisfied before an employer can legally treat a worker as an “independent contractor” for purposes of California’s labor laws:

  • The worker must be free from the control and direction of the payor in connection with the performance of the work, both under the contract and in fact;
  • The worker must perform work that is outside the usual course of the payor’s business; and
  • The worker must be customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed by the worker for the payor.

If a worker truly is “independent” pursuant to the three formalities required by Section 2750, then the payor, as a “non-employer,” would not be obligated to withhold State taxes or be subject to anti-discrimination, health-care, pension, minimum wage, the payment of overtime, worker’s compensation or unemployment insurance obligations. A September 12th editorial in the New York Times enthusiastically supported the measure: “Corporate America has made a lot of money by treating millions of workers as independent contractors, denying them basic legal protections enjoyed by employees. California [has now taken] an important step to curb that sham.”

The motivation for California’s adoption of Section 2750 was framed in the same New York Times editorial: “The practice of [hiring large numbers of contractors and treating them as an inferior grade of employee] is pervasive, but it has reached new extremes with the rise of … Uber and Lyft….” Any number of local governments have tried to defenestrate Uber and Lyft – defenestration is defined as “throwing someone out of a window,” a fitting description for many people’s impression of what should be done to disrupters of people’s lives like Uber and Lyft. Governments have had a variety of reasons for attempting to limit or eliminate Uber and Lyft from doing business in their jurisdictions, including a belief that drivers working for Uber and Lyft are being exploited and that competing taxi drivers are being unfairly disadvantaged by Uber’s and Lyft’s monopolistic-like pricing advantages. California quite clearly determined that something needed to be done about Uber and Lyft … and Section 2750 was its colloquial targeted coupe de grace defenestration.

Uber, however, is determined not to be thrown out of that threatened window! On September 11th, Tony West, Uber’s chief legal officer, declared that Uber is not in the business of providing rides, but rather is “serving as a technology platform for several different types of digital marketplaces.” Uber therefore will not treat its drivers as “employees” despite Section 2750 and, added Mr. West, Uber “is no stranger to legal battles.”

Apparently not!

Is Section 2750 therefore only about Uber and Lyft? Not surprisingly, it’s also about money, specifically money that California hopes to collect in taxes by reclassifying “independent contractors” as “employees.” That, however, appears to be largely about collecting more taxes from Uber and Lyft.

You be the judge.

In enacting Section 2750, California’s legislators were sensitive to certain donors lobbyists constituencies that might be unfairly damaged by the new law … and that didn’t mean Uber or Lyft. A number of industry groups lobbied successfully to secure exemptions for categories of workers that had historically been treated as “independent contractors” – and necessarily had a longer “history” with legislators in Sacramento than Uber or Lyft –, including (i) individuals licensed by the Department of Insurance, (ii) real estate licensees, (iii) physicians, surgeons, dentists, podiatrists, psychologists and veterinarians licensed by the State, (iv) licensed lawyers, architects, engineers, private investigators and accountants, (v) securities broker-dealers and investment advisors and their agents/representatives registered with the SEC or FINRA or licensed by the State, (vi) direct salespersons who otherwise meet Unemployment Code conditions, and (vii) certain commercial fishermen. Those are a lot of exemptions! Interestingly, the entertainment industry – Hollywood – did not receive a carve-out despite the apparent impact the new law will have on movie- and television-studio employment arrangements. Actors and extras are almost never “employees.” In providing acting services to studios they are independent talent-for-hire. But starting on January 1st, those arrangements will fail the second requirement of Section 2750 that “the worker must perform work that is outside the usual course of the payor’s [the studio’s] business.” Since that never will be the case, Section 2750 will re-classify actors as “employees” …, and they won’t like that. Neither will the studios that will have additional California tax liability (which may lead them to move their production to somewhere other than California).

This adds “complexity.” And unintended consequences.

But wait. There’s more.

Section 2750 is a California, not a Federal, labor law. It defines as “employees” those persons who California has determined are entitled to protection against discrimination and to health-care, a minimum wage, overtime pay, pensions, worker’s compensation and unemployment insurance. In effect, it also changes the California tax status of previously-categorized “independent contractors” who were entitled to deduct the costs of operating their own businesses. It does not, however, alter Federal laws, including (among others) the Internal Revenue Code and the Affordable Care Act.

Under the Internal Revenue Code, determining whether a taxpayer is an “independent contractor” requires evaluating some 20 factors to uncover the substance of the relationship – that is, whether the payor controls the method, manner and means of a worker’s business activities or the worker truly is “independent.” No one factor is controlling. The duration of the payor-worker relationship, whether it is full- or part-time, the presence of professional credentials, flexible versus rigid hours, who supplies tools and supplies, expense reimbursements, whether there is a written contract, and how payments are made all are relevant. Under the Federal tax law, determining who is an employee therefore is a fact-intensive minefield … and nothing in Section 2750 changes that. That means that there may well be any number of inconsistencies between Federal tax law and California State tax and labor law.

The Affordable Care Act defines as a full-time employee a person who works on average at least 30 hours/week or 130 hours/month. “Independent contractors” are excluded from the ACA. The test of “employee” versus “independent contractor” therefore is critical to coverage under the ACA. It will be determined by the intersection of Department of Labor, California labor and unemployment laws, workers’ compensation, and similar laws. The outcome of that analysis ought to be substantially the same as that under the Internal Revenue Code – a multi-factor weighing based on substance …, and not about California Section 2750. This will add further costs to those payors who are re-classified as “employers” under Section 2750 and make the Federal government an unintended beneficiary of California’s new law.

This, too, creates a complex mess.

Prudent California employers will treat all workers who are or might be “employees” under new Section 2750 as “employees.” It’s the safe thing to do, whatever the realities are or should be. The potential State law litigation and penalties are not worth risking. Employers naturally will treat those same workers as “employees” for Federal tax purposes. That also seems the safe thing to do …, but that will expose those employers to potential litigation by those workers (and their contingent-fee lawyers) who believe (or allege) that for Federal tax and other purposes, they’re independent contractors. “Employee” status also will create potential liability for employers concerning the actions of their newfound “employees,” which the employers will have to insure against. In short, there will be costs.

Section 2750 of course is intended to force gig companies, Lyft and Uber among them, to share their revenues with their workers … and Lyft and Uber are not poster-children for sharing revenues with underpaid drivers. However, it just as easily could require them to pass along price increases to consumers … or eliminate workers through automation or lay-offs. Going out of business also may be a regrettable alternative for many subsistence gig operators. Both Lyft and Uber are venture capital buccaneers that have been losing, and continue to lose, massive amounts of money in trying to carve out a new business paradigm. They would significantly reduce their chances of success survival by sharing their revenues with their workers, so it’s exceedingly unlikely that they will adopt the first alternative – and Uber already has said it will not. The second alternative of passing along price increases to consumers also is unappealing. It would decrease ridership and thereby decrease the odds of success survival. It’s the equivalent of adding a tax to the cost of rides and at best would mean that California consumers would bear the burden of higher government-mandated prices. The third alternative correctly focuses on the fact that both Lyft and Uber indeed are technology platforms (as Uber is claiming) and their business plans anticipate the goal of automating away their workers …, which Section 2750 is likely to accelerate. That clearly is not the purpose of Section 2750.

The New York Times editorial concludes with the recommendation that California grant gig workers who otherwise are “independent contractors” the right to bargain collectively with their newfound “employers.” That, argues the editorial writers, is a “necessary step” and “other states should follow close behind [California]. It’s not enough [for States] to raise the minimum wage or to mandate family leave. Legislatures also must act to ensure those standards apply broadly.”

California dreaming.

Finally (from a good friend)

*┬® Copyright 2019 by William Natbony. All rights reserved.

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