Alabama Governor Signs Law Harmonizing Tests for Employee vs. Independent Contractor Status

We have previously written about the growing complications of employee vs. independent contractor classification in the wake of unemployment assistance in the pandemic era, not only for out-of-work employees but, for the first time, self-employed individuals. In that newsletter, we referenced House Bill 408 that was making its way through the Alabama Legislature, which aims to add clarification to this classification quandary for Alabama businesses. 

On April 19, 2021, Gov. Kay Ivey signed House Bill 408, sponsored by Rep. Wes Kitchens (R-Marshall County/Blount County) and Sen. Clay Scofield (R-Guntersville), into law as Act 2021-226, which will become effective July 1. A bipartisan group of state representatives and senators supported the law, evidenced by the fact that it passed unanimously (99-0, 31-0) in both chambers. The Business Council of Alabama, Manufacture Alabama, and the Birmingham Business Alliance each advocated for the bill, and it was supported by the Governor’s office.

We expect this legislation to help employers avoid unnecessary misclassification assessments and steep penalties, since it requires both the Alabama Department of Labor (ALDOL) and Alabama Department of Revenue (ALDOR) to follow the IRS’s traditional common law test, also known as the “20-factor test,” which has been around for decades. That test tends to be more pro-employer. By contrast, the United States Department of Labor (USDOL) has several tests it uses, depending on which federal statute it is enforcing, all of which tilt toward finding a worker to be an employee, even if only a part-time employee.

In the case of IRS audits, many taxpayers have the Revenue Act of 1978 Section 530 “safe harbor” that can protect them from reclassification even if they fail the 20-factor test. The new Alabama law also recognizes the federal safe harbor, for both payroll tax and labor law purposes. That statute requires the alleged employer to prove it (a) had a “reasonable basis” for having classified the workers in question as independent contractors; (b) issued Forms 1099-MISC each year to those workers; and (c) treated similar workers as contractors and not employees.

 “This new law will provide a safety net for employers when it comes to properly classifying their workers,” said Drew Harrell, vice president of Governmental Affairs for the BCA. “This will also provide small businesses with clear and uniform guidelines on employee classification and will create an environment where [in most cases] they only have to be concerned with following one set of standards...” The ALDOL convinced the sponsors to add an amendment to the bill that exempts workers’ comp determinations from the new rules.

We’ve also been following this issue recently in a number of other states, most notably in California with the passage of Assembly Bill 5, which is an incredibly broad bill that forces most employers in that state to classify their contractors as employees. Soon after, a statewide referendum led by a number of California-based employers limited the scope of AB 5 to certain industries, such as ride-sharing programs and gig workers (as the bill had been advertised), and effectively created an intermediate classification that many call “employee-lite.” Many states are closely watching California, while several other states have initiated programs focused on auditing their employers for this issue -- often funded by the USDOL. For further information, please contact one of the newsletter authors, Bruce Ely or Anne Knox Averitt.