On April 30th the California Supreme Court issued a ruling that will require companies generating revenue in California to reevaluate how they classify their payees; or face steep fines for non-compliance.

One of the core functions of accounts payable departments that are often overlooked involves determining who it is they are actually paying. For instance, are you paying a contractor or an employee? As of this Monday those companies doing business and generating revenue in California have a new test to determine whether someone should be classified as an employee or independent contractor under state law and thus 1099 or W-2 reportable. The state supreme court said that a three-factor “ABC” classification is the correct test for determining worker classification under state law.

In doing so they thus moved from a separate standard that was much more friendly to finding that a worker was a 1099 reportable contractor and not a W-2 reportable employee. As a result many organization just like yours that are right now making payments to a worker could be doing so in violation of the law and thus be misclassifying workers that were lawfully classified last week.

This week's California Supreme Court ruling means that the burden of proof is on your accounts payable department (and organization) to prove under a three-part balancing test that a worker should be considered 1099 reportable and not W-2. Thus, you have a new due diligence/compliance task to determine whether or your contractor payees are truly employees.

This three factor test revolves around whether (A) the worker has freedom from control over how to perform the service, (B) the service is outside the business’s normal variety or workplace, and (C) the worker is engaged in an independently established role. All three of these conditions must be satisfied for someone to be considered a 1099 reportable independent contractor. If any of A, B, or C isn’t present, the worker is considered a W-2 reportable employee.

For instance, if your contractor is working from home using intellectual property provided by your organization they would probably be considered employees. To prove otherwise your organization would have to show it does not control and direct the worker, and that the worker is truly an independent business operator, not just classified that way unilaterally.

As part of your in-year compliance we cannot stress enough that this is something your organization must look at if for no other reason than the fact that if you are a business of any kind of reach it is highly unlikely that you are not generating revenue from business activities in California. Note also that this same test is the law in states like New Jersey and Massachusetts.

This week's TIR Answer Center subscriber only tax tip delves further into the three part "ABC" test. Remember, the TIR Answer Center subscribers don't just get on-call tax attorneys providing written answers to all of their information reporting related questions in two-business days or less - they also get access to our huge database of previously answered questions, tax tips, articles, and more! Please do not hesitate to inquire further if you need help or would like a subscription quote tailored to your organization.