Each state has its own unemployment compensation law administered by a state agency, often called the department of labor. Each state’s law defines who is and who is not an employee for unemployment compensation purposes. Almost all states fall into one of three categories:
- the common law test
- a three-part ABC test, and
- a modified ABC test.
Find the category for your state on the list below and then read the appropriate discussion in Section 1, 2 or 3. This should give you a general idea of whether a particular worker is an employee or IC for UC purposes. For more detailed information, contact the unemployment compensation agency in your state. Most of these agencies have websites and free information pamphlets. Michigan, Oregon, Wisconsin and Wyoming do not fit into any of the three standard categories. We discuss the tests for these states in Section 4, below.
1. The Common Law Test
Many of the most populous states—including California, Florida, New York and Texas—use the common law test to determine whether a worker is an employee for UC purposes. Under this test, a worker is an employee if the person for whom he or she works has the right to direct and control how the work is performed, both as to the final results, and as to the details of when, where and how the work is to be done.
This is the same test that the IRS uses to determine if a worker is an employee or IC for federal unemployment tax (FUTA) purposes, although not all states use the test in exactly the same way as does the IRS. See Federal Taxes and the IRS Rules for a discussion of the common law test as applied by the IRS.
Generally, any worker who qualifies as an IC under the IRS’s version of the common law test would also be an IC under a state unemployment agency’s common law test. However, there are no guarantees. Classifying a worker under the common law test is far from an exact science and, particularly in borderline cases, opinions may differ. State unemployment agencies are not bound by a determination by the IRS that a worker is an IC, so it is possible that worker could be deemed an IC by the IRS and an employee by the hiring firm’s unemployment compensation agency. It’s a good idea to obtain detailed information about how your state unemployment agency applies the common law test. All state unemployment agencies have websites or you can call or visit your agency. See the end of this chapter for contact information for all state unemployment compensation agencies.
2. The ABC Test
About half the states use a statutory test written by their legislatures to determine if a worker is an employee for unemployment compensation purposes. This test is called the ABC test because it contains three parts.
The Strictest Test Around
The full-blown ABC test is the most strict worker classification test. It is possible for a worker to qualify as an IC for IRS and other purposes under the less strict common law test and still be an employee under the ABC test for state unemployment compensation purposes. This means that you could classify a worker as an IC for IRS purposes and as an employee for state UC purposes. You wouldn’t withhold or pay federal payroll taxes, but would pay state UC taxes.
But this poses practical problems. Paying UC taxes for a worker makes the worker look like your employee. You could attempt to explain to an IRS auditor that your state has an extremely strict ABC test, but the auditor will still likely view payment of state IC taxes for a worker as a strong indicator of employee status. The safest course is to classify a worker who fails the ABC test as an employee for all purposes.
To qualify as an IC for state unemployment compensation purposes, a worker must satisfy all three prongs of the ABC test. You must show that:
- The worker is free from your control or direction in performing the services, both in any oral or written contract of service and in reality.
- The worker’s services are either outside your firm’s usual course of business, or performed outside of all of your places of business.
- The worker is carrying on an independently established trade, occupation, profession or business.
- If any one of the three prongs of the ABC test is not satisfied, the worker will be classified as an employee for unemployment compensation purposes—and you must pay state unemployment compensation taxes for that individual.
a. Prong A: Control or direction of the work
The first part of the ABC test, Prong A, requires that you not have the right to exercise control or direction over the worker’s services. Your control must be limited to accepting or rejecting the results the worker achieves, not how he or she achieves them. This is simply a restatement of the common law right of control test—the test used to determine worker status for IRS and many other purposes. (See The Common Law Test for a discussion of the IRS test.)
The factors state UC auditors examine to determine if you have the right to control a worker differ somewhat from state to state and are determined by state UC laws, regulations and court rulings. For example, Maryland regulations provide that a worker is considered to be free from a hiring firm’s direction or control if the firm does not:
- require the worker to comply with detailed instructions about when, where and how the person is to work
- train the worker
- establish set hours of work
- establish a schedule or routine for the worker, or
- have the power to fire the worker for failing to obey specific instructions. (Md. Regs. Code title 24, § 24.02.01.18(B)(3)(a).)
In Oklahoma, unemployment compensation auditors focus on a slightly different set of factors, including whether the hiring firm:
- provides the worker with tools and equipment
- pays the worker’s business expenses
- assumes all financial risks involved with the work
- hires the worker’s assistants, and
- obtains and maintains all business, tax and occupational licenses.
To find out the details of your state’s test, you will have to contact the agency in your state that enforces unemployment compensation laws. (See Section C, below, for contact details.)
b. Prong B: Outside service
The second part of the ABC test focuses on whether the worker’s services are outside your normal business. Prong B is satisfied if either:
- the worker’s service is outside the usual course of your business operations, or
- the work is performed completely outside your usual places of business.
Usual course of business operations. State auditors seek to determine whether the worker’s services are an integral part of—that is, closely related to—your normal daily business operations. You’re likely to exercise control over such workers because they are so important to your business’s success or continuation.
EXAMPLE 1: Jeremy works part time on the assembly line at the General Widget Corp. Jeremy helps assemble widgets, which is what General Widget is in the business of producing. Jeremy’s services are essential to the nature of General Widget’s business because it can’t produce widgets without people working on the assembly line. Jeremy therefore can’t satisfy Prong B because he does not work outside the hiring firm’s normal course of business.
EXAMPLE 2: General Widget Corp. hires Jessica, an attorney with her own practice, to defend it in a products liability lawsuit. General Widget is in the business of producing widgets, not defending lawsuits, so Jessica’s services are outside General’s normal business, satisfying Prong B.
Work performed outside the business. Even if a worker’s services are an integral part of your business operations, you can still satisfy Prong B if the worker’s services are performed outside your place of business. In other words, the worker must not work on any of your firm’s business premises.
EXAMPLE: General Widget Corp. contracts with Arnie to provide important component parts for its widgets. Arnie builds the components in his own workshop and delivers them to General. Arnie’s services are an integral part of General’s business operations, but Prong B is still satisfied because Arnie performs the services at his own business premises.
Some states that use the ABC test take the position that if a hiring firm has no fixed place of business—for example, a sales firm—a worker cannot satisfy the off-premises test if the services are performed at a temporary work site or where customers or prospective customers are located. This can make it impossible for workers for many types of hiring firms to qualify as ICs for unemployment compensation purposes.
EXAMPLE: Sam is a home widget installer. He works for a number of different widget sales companies, including Best Buy Widgets. When Best Buy obtains an order, it tells Sam and he goes to the customer’s house to install the widget. He does no widget installing at Best Buy’s sales office. Sam cannot meet the off-premises test in most states that use the ABC test because he works at temporary work sites where Best Buy’s customers are located—their homes. He would be deemed an employee of Best Buy for unemployment compensation purposes.
c. Prong C: Independent business or trade
The final part of the ABC test requires that the worker be engaged in an independently established trade, occupation, profession or business. This means that the worker’s business activity must exist independently of, and apart from, the service relationship with the hiring firm. It must be a stable, lasting enterprise that will survive termination of the relationship with the hiring firm.
Some of the ways you can show that a worker is in an independent business or trade include proof that the worker:
- has a separate office or business location
- maintains a business listing in the telephone directory
- owns the equipment needed to perform the services
- employs assistants
- has a financial investment in the business and the ability to incur a loss
- has his or her own liability or workers’ compensation insurance
- performs services for more than one unrelated hiring firm at the same time
- is paid by the job rather than by the hour
- possesses all applicable business licenses, and
- files business (Schedule C) federal income tax returns.
3. Modified ABC Tests
Eight states use a modified version of the ABC test. These states do not require that all three prongs of the standard ABC test discussed above be satisfied; they drop one of the three requirements. The following list shows which prongs of the ABC test these states use.
Colorado, Idaho, Montana, Pennsylvania and South Dakota drop the B outside-service prong. In these states, a worker will be considered an IC for unemployment compensation purposes if he or she is not under the direction and control of the hiring firm and is engaged in an independent business and trade.
Kansas drops the C independent-business prong. In Kansas, a worker will be an IC for unemployment purposes if he or she is not under the hiring firm’s direction and control and the work is either outside the hiring firm’s usual business or is performed outside the firm’s business premises.
In Oklahoma and Virginia, a worker qualifies as an IC if either the AB or AC prongs are satisfied—that is, lack of control plus outside service; or lack of control plus independent business.
Obviously, it is somewhat easier to establish that a worker is an IC in these states than in those that require that all three prongs of the ABC test be met.
4. Other Tests—Michigan, Oregon, Wisconsin and Wyoming
Four states—Michigan, Oregon, Wisconsin and Wyoming—do not use either the ABC test or a modified ABC test.
a. Michigan
Michigan uses an economic reality test to determine if a worker is an employee. This test focuses on the economic reality of the relationship between worker and hiring firm, rather than looking exclusively at the right to control the worker. A worker who is economically dependent upon the hiring firm is the firm’s employee. The factors are:
- who controls the worker’s duties (control by the hiring firm indicates employee status)
- how the worker is paid (hourly payment indicates employee status, payment by the project indicates IC status)
- whether the hiring firm has the right to fire and discipline the worker (if so, employee status is strongly indicated), and
- whether the performance of the worker’s duties are an integral part of the hiring firm’s business toward the accomplishment of a common goal.
b. Oregon
Oregon has a single test that is used to determine the employment status of workers for unemployment compensation, workers’ compensation and state income tax purposes. Under this test, a worker is an IC only if all the following eight factors are met:
- the worker is free from the hiring firm’s direction and control in performing the services, although the firm can specify the desired results
- the worker is responsible for obtaining all applicable business licenses and registrations
- the worker furnishes the tools and equipment needed to perform the services
- the worker has the authority to hire and fire assistants
- payment is made on completion of specific portions of the project or is made on the basis of an annual or periodic retainer and not hourly
- the worker is registered with the state if required by Oregon law
- federal and state income tax returns in the name of the worker or the worker’s business (Schedule C) were filed for the previous year if the person worked as an IC the previous year, and
- the worker is engaged in an independently established trade or business.
c. Wisconsin
In Wisconsin, a worker is an IC for UC purposes if he or she (1) holds or has applied for an employer identification number from the IRS or has filed business or self-employment income tax returns with the IRS for the previous year, and (2) meets six or more of the following conditions:
- the individual maintains a separate business with his or her own office, equipment, materials and other facilities
- the individual operates under contracts to perform specific services for specific amounts of money under which the worker controls the means and method of performing the services
- the individual incurs the main expenses for the services performed
- the individual is responsible for the satisfactory completion of the services and is liable for failure to satisfactorily complete them
- the individual is paid solely on a commission or per-job or competitive-bid basis
- the individual may realize a profit or suffer a loss
- the individual has recurring business liabilities or obligations, or
- the success or failure of the individual’s business depends on the relationship of business receipts to expenditures.
d. Wyoming
Wyoming looks at three factors to determine if a worker is an employee for UC purposes. A worker is an IC if he or she:
- is free from control or direction over the details of the performance of services by contract and in fact
- represents his or her services to the public as a self-employed individual or an independent contractor, and
- may substitute another individual to perform the services.
5. Statutory Employees
Federal law requires that certain types of workers must be covered by unemployment insurance, even if they qualify as ICs:
- corporate officers
- drivers who distribute food products, beverages or laundry, and
- traveling or city salespeople.
These workers are called statutory employees.
Most states also require that state unemployment compensation be paid for statutory employees. The only exceptions are Georgia, Maryland, Massachusetts, Montana and New Hampshire. If you hire a statutory employee in one of these states, you must pay the full 6.2% FUTA tax, since you won’t receive a credit for paying state unemployment taxes.
However, the following 14 states exclude some or all corporate officers from receiving state unemployment insurance: Alaska, California, Delaware, Hawaii, Iowa, Michigan, Minnesota, New Jersey, North Dakota, Oklahoma, Oregon, Texas, Washington and Wisconsin. If you live in one of these states, check with your state unemployment agency for more information.
California Rules for Construction Contractors and Authors
California contractors must pay careful attention to some especially strict unemployment compensation rules. If you hire an unlicensed worker or unlicensed subcontractor to perform work requiring a contractor’s license, you’re automatically deemed the worker’s or subcontractor’s employer for all state payroll tax purposes, including unemployment compensation and state income tax. (Cal. Unemployment Ins. Code § 621.5, Cal. Labor Code § 2750.5.)
EXAMPLE: Tom, a licensed contractor, agrees to do a room addition. Lacking the time to do the job himself, he subcontracts the work out to Bill, who does not have a construction contractor license. Although Bill would easily qualify as an IC under the normal rules, he is considered Tom’s employee because he is unlicensed. Tom must pay all applicable California payroll taxes for Bill.
Neither the IRS nor virtually any other state has a rule similar to California’s. Bill, in the example above, would be an IC for IRS purposes and would be an IC in most other states as well.
In addition, California law provides that the author of a work commissioned by another is deemed the employee of the commissioning party for state payroll tax purposes if the work is done under a written agreement specifying that the work is made for hire.
6. Exemptions From Coverage
Most states exempt certain services from unemployment compensation coverage. This includes services performed by:
- your spouse, minor children or parents (but services by a parent are not exempt in New York)
- licensed real estate brokers who work on commission, and
- real estate salespeople who work on commission.
But the most important exemption from unemployment compensation coverage is for casual labor. Casual labor is a term used by hiring firms to describe temporary or part-time workers. Under the laws of most states, workers performing casual labor are not covered by unemployment compensation if the services are not performed within the hiring firm’s course of trade or business.
EXAMPLE: The Leopold and Loeb law firm hires John to paint one of its offices. Painting does not fall within the law firm’s trade or business, so John may qualify for the casual labor exemption.
Fighting Unemployment Compensation Claims
If a worker you classified as an IC files a claim for unemployment compensation, you don’t have to simply accept the worker’s assertion that he or she should have been classified as an employee. You have the right to fight the worker’s claim, both in administrative proceedings before the state unemployment agency and, if this fails, in state court.
Procedures differ from state to state, but are generally handled in the following way.
First, the worker will file a claim with the state UC agency. You’ll be notified in writing of the claim and can file a written objection, usually within seven to ten days. Be sure to review your state’s worker classification test and timely file an objection explaining why the worker is an IC. Include copies of documentation showing that the worker is in business for himself or herself. You should already have this material in your files.
Next, the UC agency will determine if the worker is eligible to receive UC benefits. There’s usually no hearing at this stage.
If either you or the worker doesn’t like the UC agency’s ruling, you can demand a hearing. This is usually held at the UC agency’s office before a hearing officer on the agency’s staff, called a referee in many states. You should present your written documentation showing that the worker was an IC, not your employee. You can testify yourself and also present oral testimony from witnesses—for example, supervisors or other people who dealt with the worker. The more relevant persuasive evidence you have, the better off you’ll be.
Before the hearing, ask to see the UC agency’s complete file on the claim, since it may contain inaccurate statements you’ll need to refute.
You’re entitled to have an attorney represent you at the hearing. If you can afford it, this is not a bad idea, because an adverse ruling may result in audits of other workers you’ve classified as ICs by the UC agency and other government agencies, including the IRS.
Either side can then appeal the UC hearing officer’s ruling to a state administrative agency such as a board of review. You should usually hire a lawyer to do this. Such appeals are usually not successful.
Finally, you can appeal to your state courts. Again, you will probably need the help of a lawyer to do this. Your appeal will likely fail unless you can show the prior rulings were contrary to law or not supported by substantial evidence.
However, the casual labor exemption is lost if the worker performs services for more than 24 days during a calendar quarter—that is, any three-month period—or during the previous calendar quarter.
EXAMPLE: John, the painter, works for Leopold and Loeb for 25 days in March and 15 days in April. He doesn’t qualify for the casual labor exemption for either the first or second calendar quarter. He worked more than 24 days during the January-February-March calendar quarter, so the exemption is lost for that quarter. In addition, the exemption is lost for the April-May-June calendar quarter because he worked more than 24 days during the previous quarter.
The following states do not have a casual labor exemption: Delaware, Idaho, Illinois, Iowa, Kansas, Maine, Michigan, Missouri, Nevada, New Jersey, New Mexico, New York, Oklahoma, South Dakota, Tennessee, Texas, West Virginia, Wisconsin and Wyoming.