Until recently, the test for determining if a worker was an employee or independent contractor was whether the payor had the right to direct the manner and means by which the worker performed the services. There were a number of factors taken into consideration, but the purpose of applying the factors was to answer that ultimate question.
Because of the vagueness of the test and the number of factors, it was often difficult to predict how a court would rule. In order to make the line clearer, the California Supreme Court adopted a very expansive definition of “employee” in a recent case, Dynamex Operations West Inc. v. Superior Court. Under this new test, a worker is considered to be an independent contractor only if all three of the following factors are present:
- 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.
Applying this test, the court held that truck drivers were employees of the company they worked for. This new test casts a wide net that will result in many “independent contractors” in the entertainment industry being reclassified as employees. In particular, the second factor listed above could be used to argue that almost everyone in the entertainment industry is an employee.
Even before this case, under California Labor Code section 3351.5(c), if a service contract has “work made for hire” language, the worker is automatically deemed to be an employee, and almost all contracts in Hollywood have this language.
While the new case and the Labor Code section above apply for labor law purposes, they will almost certainly be applied by the courts and employers for tax purposes as well, since it is too difficult to bifurcate the treatment of workers as employees for labor law purposes and as independent contractors for tax purposes. For tax purposes, the stakes are high to the payor regarding the distinction between independent contractor and employee; if the payor guesses wrong and does not withhold payroll taxes, the payor and the individuals who control payment are all liable for the taxes that should have been withheld if the worker is later deemed to be an employee by the tax authorities.
One painful aspect of this change of law under Dynamex is that it follows on the heels of the new tax bill, which denies the deduction of any business expenses for employees. Thus, a wide swath of workers will no longer be able to deduct any of their bona-fide business expenses.
One critical open question under Dynamex is whether loan-out corporations will be respected as “independent contractors,” since if they are respected, the loan-out can deduct the worker’s business expenses. Based on existing case law that knocked out loan-outs for athletes, the IRS could probably knock out all talent loan-outs if it chose to litigate the issue, but for some reason the IRS has not challenged talent loan-outs for thirty years. Loan-outs probably don’t work for below the line workers, and they certainly don’t work for anyone that has a full time job with one payor.
The last, and most important question, is what will the studios do? I have been advised that at least two studios that used to respect loan-outs for below the line workers no longer do so after Dynamex. Even though Dynamex did not deal with loan outs, a cold wind is blowing, so this change in practice is not surprising.