***The new Cal Supreme Court case of Dynamex v. Superior Court regulating who is an “employee” vs. “independent contractor.” (Major payroll tax implications for businesses and their purchasers).***

Pete,

I’m a business opportunity broker. My client is purchasing a machine parts manufacturing business which hired its fleet of 10 delivery drivers of its goods “as independent contractors” rather than as “employees.” (The business pays them “gross wages,” i.e., the
workers are responsible for paying their own income taxes, and pays no payroll taxes for them.) I’ve heard that a new California Supreme Court case called “Dynamex Operations v. Superior Court” [4 Cal.5th 903] requires that drivers be treated as “employees,” i.e., that the
company must pay payroll taxes for them in addition to what it’s been paying to the drivers “as independent contractors.” This sounds like a potential nightmare for my purchasing client. Even though our agreement says that he’s to rely upon his accountant, not me, for tax advice, what are the tax consequences to him? For they may impact my ability to close the deal.

Answer:

Before the Cal Supreme Ct’s Dynamex case [4 Cal5th 903] was decided on April 30, 2018, whether a person was considered an “employee of” or an “independent contractor to” a business turned on the common law “control” test: Did the employer control (a) the worker’s hours, (b) the location of where he worked, or (c) the instrumentalities of his work, e.g., vehicles?

If the worker, despite having a written “independent contractor” agreement with the business, had his hours of work, location, or instrumentalities of his work, controlled by the business, both the federal and state governments could treat the worker as an “employee” of the business, and force the business to pay payroll taxes to the government on top of what the business was paying in compensation directly to the worker.

Businesses so assessed by the federal and/or state taxing agencies, i.e., by the IRS or EDD, could be financially squeezed trying to pay such accrued payroll taxes. To avoid payroll tax assessments, smart businesses would be sure to provide in their “independent contractor” agreements that the worker (a) controlled his own hours or work, (b)
used his own vehicle or instrumentalities of work, and (c) was free to work at locations other than of the employers, and that (d) the facts of employment bore those out.

New Test per Dynamex:
In Dynamex, one of its truck drivers delivering its goods worked for 3 months as an “independent contractor,” left, and sued Dynamex to be treated as an “employee” to cover his income taxes as its payroll tax obligation. He contended, among other things, that even if the
business didn’t control his work hours or his vehicle used, or where he physically performed his work, that he should still be considered an “employee” if he had no independent business of his own he used for the work.

The California Supreme Court agreed with him on 4-30-18, setting forth the following test of who is an employee: – all workers are presumed to be employees unless the hiring
business rebuts that presumption proving that the worker satisfies each of three conditions (the “ABC Test”):

1. “(A) (sole traditional test) the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the written agreement and in fact;
2. (B) (new caveat) the worker performs work that is outside the usual course of the hiring entity’s business; and
3. (C) (additional new caveat) the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work.”

These are radical changes. So, if the newly purchased business wants to guard against “employee” status, the business needs two things:

1. (a) to be restructured so that it is no longer directly engaged in driving the business’s goods to its customers, e.g., it terminates it fleet of drivers, cancels insurance on them, and…
2. (b) its drivers themselves must be employed by an
   independently established business with whom the business contracts.

This is probably too much restructuring in which the business is to engage, so it may simply choose to begin paying its drivers as employees, absorbing the increased payroll tax burden, pleasing the tax authorities.

Bulk sale transfer law, if complied with through escrow, will protect the buyer from existing tax obligations of the seller. But it won’t protect against prospective ones if the IRS or EDD decides to assess the new business for payroll taxes on its drivers.

What are the payroll tax implications of the Dynamex case on your buyer’s newly purchased business:

1. Does the business have a potential problem with its independent contractors being considered employees by the taxing authorities?
2. How much in dollars and cents on a quarterly basis could this impact the business, according to buyer’s accountant?
3. Should the business now switch its drivers to “employee status,” and what will that cost in payroll taxes quarterly?

You may want the buyer’s accountant to answer these questions before allowing the buyer to enter into the purchase contract so the buyer doesn’t later confront you when it comes time to pay your commission.

Your buyer’s purchase agreement could include an addendum drawn by legal counsel advising the buyer of these three particular payroll tax issues and that buyer is relying on his own accountant, not upon you, for advice/guidance on them. Otherwise, he could contend that your
general disclaimer in your broker’s agreement with him protects you only from the tax consequences of his purchasing the business, not what the IRS or EDD may do to it afterward.

Need more help? Contact me for a free consultation.