Whether a “worker” is properly characterized and treated as an “employee” or as an “independent contractor” is a complex—but increasingly important—inquiry for business owners and their advisors. Spurred by the COVID-19 pandemic, the continued expansion of the gig economy as well as the rapid shift to remote work are two factors drawing increased attention to these issues.

Federal and state rules vary, but worker misclassification enforcement is becoming a growing priority for government auditors. In New Jersey, there have been some noteworthy developments, including the recent $100 million payment by Uber Technologies, Inc., to settle a worker classification unemployment insurance audit, the largest such payment in state history.

Worker Classification Basics

Proper classification can be murky, because there are often overlapping but different tests depending upon the matter (e.g., income tax, payroll tax, unemployment insurance, wage & hour) and governmental agency (e.g., tax, labor, federal, state) at issue, which could lead to different results. As a general proposition, though, all classification rules examine these two sides of the same coin: 1) the degree of the worker’s independence from the payor and 2) the degree of the payor’s control over the worker. Employees work for, and under the supervision of, their employers, who control what will be done and how it will be done. Contractors, though, are self-employed and have independence from the payor, who can control only the result of the work, not how it will be performed.

This distinction is significant. Employers owe substantial legal duties to their employees, including adherence to wage and hour laws, state and federal income tax wage withholding, payment of unemployment and Social Security taxes, and workers’ compensation and disability insurance, among many other labor law protections. Generally speaking, independent contractors are not entitled to any of these benefits; all payors need to do is pay the contracted rate and issue a Form 1099. Consequently, classifying a worker as an employee or as a contractor has a significant effect on the costs of hiring that individual.

Various Worker Classification Tests

Increasingly, government auditors view misclassification as an illegal means deployed by businesses to improperly reduce their labor costs. Sometimes that may well be true, but with the workforce increasingly splintered and fractured with the rise of the gig economy and remote work, determining whether a worker really is an employee or independent contractor may not always be “illegal,” it may just be difficult.

Over the decades, the courts, government agencies, and state legislatures have crafted many different tests for different contexts in an effort to aid in the determination of whether a worker qualifies as an employee: the “common law” factor balancing test; the IRS’s historic 20-factor test; the IRS’s more recent three-category test (behavior control, financial control, type of relationship); the U.S. Department of Labor’s six-factor “economic realities” test; the “relative nature of the work test” for workers’ compensation purposes; and the 12-factor “right to control test” under ERISA.

In discussing its three-category test, the IRS’s website appropriately cautions: “There is no ‘magic’ or set number of factors that ‘makes’ the worker an employee or an independent contractor and no one factor stands alone in making this determination. … The keys are to look at the entire relationship and consider the extent of the right to direct and control the worker” (IRS.gov). In other words, this is a facts-and-circumstances analysis requiring a detailed and nuanced examination of each individual situation.

The remainder of this article will focus on the “ABC test,” utilized by certain states, including New Jersey (for wage and hour and unemployment insurance purposes), which tightens the analysis in favor of employee status and should give business owners pause.

The ABC Test

Under New Jersey’s ABC test, a worker is presumed to be an employee unless the employer can demonstrate that all three prongs of the ABC test are met. The three prongs are as follows:

  • Such individual has been and will continue to be free from control or direction of the performance of such service, both under their contract of service and in fact;
  • Such service is either outside the usual course of business for which such service is performed, or such service is performed outside of all the places of business of the enterprise for which such service is performed; and
  • Such individual is customarily engaged in an independently established trade, occupation, profession, or business. [NJSA 43:21-19(i)(6)(A-C)]

The ABC test purports to be a similar formulation to the above-mentioned tests. It seeks to enquire whether the worker is free from the payor’s control, the nature of the service performed, and whether the worker otherwise operates independently. The test is conjunctive, however, meaning failing one prong confirms the worker is an employee. Furthermore, the party challenging the classification (typically the employer) carries the burden of proof.

Although the ABC test is not new, the New Jersey Department of Labor and Workforce Development used this test in 2022 to claim two legal victories in the unemployment insurance enforcement arena. The ABC test has been criticized as imposing too high a bar on employers, reducing flexibility customary among freelancers, as well as lacking appropriate guidance regarding its application. As such, these cases, discussed below, merit careful consideration.

East Bay Drywall LLC

On August 2, 2022, the New Jersey Supreme Court ruled in favor of the government, holding that a drywall installation business, East Bay Drywall, LLC, had improperly classified 16 of its workers as independent contractors, even in instances where some of those workers had their own entity, their own business registration, and their own certificate of insurance. [East Bay Drywall, LLC v. DOL (A-7-21) (085770)(08/02/2022)].

Prior to June 2013, East Bay Drywall was registered with the Department of Labor and Workforce Development as an employer and reported wages accordingly for its employees. After that date, the company ceased reporting wages and began treating its workers as independent subcontractors, which in 2017 triggered a routine audit of 2013 through 2016. The auditor sought evidence of each prong of the ABC test for the various workers, and ultimately concluded that several of the subcontractors were indeed misclassified and issued an assessment of $42,120 in unpaid unemployment tax and temporary disability contributions.

After several rounds of appeal, the case reached the New Jersey Supreme Court with the remaining issues focused on the “C” prong interpreting the “independent business” requirement. In summary, East Bay Drywall argued that the subcontractors were open for hire to other contractors; sometimes they would leave a job before it was completed; they were free to accept or decline work; and several of the workers had formed their own entities and obtained their own insurance. The court, however, concluded that under the ABC test, East Bay Drywall bore the burden of proof and failed to meet this burden. Among other things, the court explained that East Bay Drywall did not provide sufficient evidence that the workers otherwise conducted themselves as independent businesses. For example, it failed to submit evidence demonstrating that the workers maintained independent business locations, advertised, or had their own employees. Furthermore, the business registrations and insurance certificates were inconsistent and several of the entities were delinquent. Accordingly, the court expressed concern that these entities could have been entities in name only.

The East Bay Drywall decision demonstrates the heavy burden employers face when classifying a worker as an independent contractor in New Jersey under the ABC test. It further demonstrates the necessity to document and substantiate the facts supporting independent contractor treatment, and the need to have those documents available to mount a successful audit defense.

Determining proper worker classification can be a challenging and complex inquiry. At the same time, worker misclassification enforcement is gaining traction nationally.


On September 13, 2022, a month after the East Bay Drywall decision, the New Jersey Department of Labor and Workforce Development issued a press release announcing it had received a $100 million payment from Uber Technologies, Inc., and its subsidiary after an unemployment insurance audit determined that the ride-sharing company had improperly classified 297,866 drivers as independent contractors throughout 2014 through 2018. The payment consisted of $78 million in past-due contributions, plus $22 million in penalties and interest.

Although this amount was, in fact, significantly reduced from an initial proposed assessment of $523 million, it nonetheless represents the largest such payment in New Jersey history. Although there was no public decision in this case, its seems safe to assume that Uber agreed to pay $100 million because it did not believe it could substantiate the three prongs of the ABC test.

Practice Pointers

Determining proper worker classification can be a challenging and complex inquiry. At the same time, worker misclassification enforcement is gaining traction nationally. New Jersey has taken strides to step up enforcement, and its efforts seem to be yielding results. In July 2019, New Jersey issued an Employee Misclassification Task Force Report outlining its intentions. As part of that report, the Task Force issued a letter to 20,000 licensed New Jersey accountants “educating them on the issue of misclassification.” Furthermore, in August 2022, New Jersey mailed out a worker classification questionnaire to DoorDash drivers related to its audit of that large gig economy employer. It seems likely that New Jersey will increase these types of audits, which may encourage other states to follow suit.

CPAs should advise business owners to take stock of their workforce. How and where does a company operate? If a company treats a portion of its workforces as independent contractors, has it done so in a thoughtful and principled manner? Does it have records to support its position and tax treatment? Should any changes be made, and, if so, are there steps to be taken to mitigate exposure? Businesses should consult with their CPA and other advisors on these issues, as the risks for all industries seem to be increasing.

Corey L. Rosenthal, JD is a principal and the state and local tax practice leader at CohnReznick LLP, New York, N.Y.
Lance E. Rothenberg, JD, LLM is the sole proprietor of Rothenberg Tax Law.