The More Things Change, the More They Remain the Same: Worker Classification in the Gig Economy

Labor & Employment Newsletter

Client Alert


What Is the “Gig Economy”?

The “gig economy” is the catchall term for an ever-growing range of temporary, flexible, autonomous work arrangements that are often enabled by technology platforms, such as websites or apps that connect workers directly to consumers. The gig economy has transformed the way that businesses, workers, and consumers interact. In the gig economy, workers have enormous flexibility to determine when, how much, and for whom they want to work.  The digital marketplace model gives businesses access to an ever-ready workforce, with virtually none of the costs associated with managing employees or providing employee benefits. Consumers receive better service, on demand, at lower prices. Sounds good? It’s complicated, because such flexibility is viewed by some as coming at the price of income stability, diminished legal protections over the workplace, and loss of payroll taxes and other revenues to governments.

“Gig” workers include Uber and Lyft drivers, Airbnb hosts, Amazon Mechanical Turk crowdsource task workers, DoorDash and Grubhub delivery services, Gigster software project workers, and a host of others. A recent survey estimates that over 57 million Americans are freelancing in the gig economy.  A recent Federal Reserve study, which included both online and offline freelancers, estimates the number of Americans participating in the gig economy to be as high as 75 million. One industry analyst forecasts that the majority of Americans will be working independently in the gig economy by 2027.

This new gig economy is not only a hotbed of innovation, but it is becoming a hotbed of litigation, particularly over the issue of worker classification -- namely whether a worker is an independent contractor or an employee for purposes of wage-and-hour protections, protection from workplace discrimination, and other federal and state employment benefits. Even before the rise of the gig economy, worker classification has been complicated by the fact that differing tests apply, depending upon whether classification pertains to income tax withholding and employment tax withholding and reporting under IRS regulations, FLSA coverage, or coverage under other employment benefit programs such as unemployment insurance or workers’ compensation. Thus, it has always been possible that application of the different tests could yield different results, with resulting uncertainty and exposure to liability for unpaid taxes or unpaid overtime. The classification issues arising in the gig economy have only complicated an already difficult determination.

Independent Contractor or Employee?

The IRS test considers 20 factors and is based upon the common law “control” test.  The three critical factors under the IRS test are (1) whether the employer has the right to direct or control the manner in which a worker completes his or her work, including whether the employer evaluates and trains the worker; (2) whether the employer has the right to control the economic aspects of the work, including whether the employer provides the equipment, whether the worker can incur economic loss as a result of performing the work, and whether the worker is free to seek out other business opportunities; and (3) the type of relationship between the employer and the worker, including how the relationship is described in written contracts, the expected duration of the work, and whether the worker’s services are a key component of the employer’s business.

 The DOL applies a multi-factor “economic realities” test that focuses on the economic dependence of the worker on the employer rather than the employer’s “control” over the worker and the work product.  As factors, the DOL considers the extent to which the work performed is integral to the employer’s business; the worker’s opportunity for profit or loss; the relative investments of the employer and the employee; whether the work requires specialized skill; the permanency of the relationship; and the degree of control exercised or retained by the employer.  While no one factor is dispositive, the focus remains on whether the worker is an independent business person or is economically dependent upon the employer.

Neither test applies easily to the new realities of the gig economy. The California judge presiding over the misclassification cases asserted against Lyft likened the application of the IRS and/or DOL tests to being “handed a square peg and [being] asked to choose between two round holes.” 

Uber and Lyft, which have been the most prominent defendants in the ongoing legal battles over worker classification, have taken the position that their drivers are independent contractors because drivers have near complete control over their schedules and location of work, have the ability to work for the competition, use their own vehicle and bear the majority of their expenses, have significant opportunity for profit or loss depending upon how they choose to operate, and have virtually no supervision by the company personnel over their performance.  Uber has also argued that its drivers carry out work that is not integrated into Uber’s business, maintaining that Uber is a technology company that hosts a digital marketplace, not a transportation company.

In those lawsuits, Uber and Lyft drivers have argued that they are clearly employees because they are subject to the control of the companies, including because the companies screen drivers, establish driver qualifications, instruct drivers to follow certain rules in providing transportation services, set the rate for fares and surge rates, evaluate drivers’ performance based on customer reviews, and reserve the right to terminate drivers at will and act on that right. 

The courts considering these opposing positions have concluded that Uber and Lyft drivers operate in a “grey area” and are neither clearly independent contractors nor employees.  Accordingly, the courts opined it would better be left to a jury to decide the classification issue as a matter of fact. Rather than risk a jury verdict unfavorable to their business models, Uber and Lyft both entered into multimillion-dollar settlements with drivers. Subsequently, both Uber and Lyft have continued to classify their workers as independent contractors, with certain modifications to their policies. As a result, the courts have not provided any clear guidance to employers on the issue of classification. Legislators and regulators have stepped in to provide guidance; however, because the regulators have taken contradictory positions on the classification of gig workers, much uncertainty remains.

Recent Regulation Affecting Classification

Several states, including Arizona, Florida, Indiana, Iowa, Kentucky, Tennessee, Texas, and Utah, have designated workers in the on-demand gig economy as “marketplace contractors” and have enacted statutes that treat marketplace contractors as independent contractors for purposes of unemployment insurance and, in some cases, for other employment benefits under state law. On the federal level, a recent NLRB Advice Letter concluded that Uber and Lyft drivers are independent contractors under the common law agency test, focusing on the fact that drivers had virtually unfettered freedom to set their schedules and, therefore, had significant control over their earnings, controlled their work locations, and were free to work for competitors.  According to the NLRB, the facts painted a picture of “entrepreneurial independence.” The NLRB further found that Uber and Lyft service standards regarding things such as minimum time to wait for riders to arrive at pickup, vehicle condition and comfort, and competent driving and navigation were too minimal to constitute control. The NLRB also took note that, in lieu of company supervision or management, Uber and Lyft relied on evaluation by consumers. Under the NLRB analysis, digital marketplace companies can make a strong case that their workers are not covered by or protected by the NLRA -- i.e., would not have the right to unionize or file a DOL charge of unfair labor practices.

Likewise, in an April 29, 2019, Opinion Letter, the U.S. Department of Labor, applying the economic realities test, opined that workers for a digital marketplace company that connects service providers to consumers are independent contractors. The DOL found that workers’ ability to choose when, how, and for whom they could work, their freedom to pursue work for other companies, and the fact that the company does not monitor, supervise, or control the particulars of work indicate a lack of control that weighs in favor of independent contractor status. The DOL also considered as factors weighing in favor of independent contractor status the impermanence of the relationship, the fact that workers supply their own equipment, and that, even though the company sets prices for jobs, workers can choose which jobs and how many to take and thereby control their opportunities for profit or loss. Most significantly, the DOL took a position on the integrality of the workers’ services to the company’s business similar to the argument advanced in litigation by Uber and Lyft (and viewed with skepticism by the California courts), namely that the workers, who provide services to customers but do not develop, maintain, or otherwise operate the company’s digital platform, are not operationally integrated into the business, the primary purpose of which is to provide a referral system to connect service providers with consumers. Thus, absent any more restrictive applicable state law, workers in the digital marketplace are not covered by the wage-and-hour protections of the FLSA and are not entitled to minimum wage and overtime.

While worker classification may have gotten simpler for gig economy businesses in the aforementioned “marketplace contractor” jurisdictions, significant uncertainties remain. Recently enacted California Assembly Bill 5 (AB5), which takes effect on January 1, 2020, sets forth much narrower limitations on when a company may properly classify a worker as an independent contractor and will almost certainly make it much harder for companies relying heavily on an on-demand work force, such as Uber and Lyft, to label workers as independent contractors. AB5 essentially codifies the decision of the California Supreme Court in the Dynamex case, which set forth what is known as the three-prong “ABC Test.” The concern of the California court, and the social policy behind AB5, was to remedy the harm to misclassified workers who lose significant workplace protections, the unfairness to competing employers who properly classify workers, and the loss to the state of needed revenues from payroll taxes and premiums for workers’ compensation, unemployment, and disability insurance.  The ABC Test requires an employer to establish: (A) the worker is free from the control and direction of the hirer in connection with the performance of the work, both under contract and in fact; (B) the worker performs work that is outside the usual course of the hiring entity’s business; and (C) the worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed for the hiring entity. AB5 may well be a sign of things to come. Several other states, including New York, Washington, Oregon, Alaska, and Pennsylvania, have similar legislative proposals in the works. On the national level, Vermont Sen. Bernie Sanders has introduced the “Work Place Democracy Act,” which would subject companies nationwide to the ABC Test. Accordingly, gig economy companies may want to be proactive in undertaking a strategic analysis of the implications of such legislation on their business model.

What Next? A New Classification?

Following the enactment of AB5, Uber and Lyft have refused to change the classification of their drivers and have announced an intent to defend any litigation, which will presumably require them to convince a court that their drivers perform work that is not integral to their business -- which they contend is hosting a digital marketplace -- or that the indirect, algorithmic control over drivers’ activation status based on customer ratings is not control “in fact” for purposes of the ABC Test. Uber and Lyft have also announced that if they lose the legal battle and are required to reclassify drivers as employees, they anticipate the need to offset an anticipated increase in costs up to 30% by cutting the number of workers and scheduling drivers in advance to avoid overtime, thereby reducing the flexibility that is currently enjoyed by drivers.  In the meantime, Uber and Lyft have embarked on a $90 million lobbying effort to support a ballot initiative to exempt them from AB5’s impact. Their efforts include trying to rekindle negotiations with the government and labor groups to create a new category of “short-term” or “on-demand” workers, somewhere between contractor and employee, who would be eligible for only certain state employment protections and benefits. Previous negotiations included the companies’ willingness to support a system of worker-determined benefits, including PTO and retirement benefits pro-rated on how often drivers work; base rate pay for drivers to increase driver pay overall; and the formation of a drivers’ association to enable drivers to connect with peers and to provide an appeal process for driver deactivations.

Although AB5, and its new ABC Test, is currently only the law in California, regional, national, and international companies with independent workers in California will need to take steps to come into compliance by the beginning of next year. Businesses everywhere, however, will need to stay updated on changing laws to apply the right test for the specific compliance issue at hand and may wish to consult legal counsel whenever they find themselves in a “grey area.”