The California Labor Commission just ruled that drivers for the San Francisco-based logistics company Uber are employees not contractors. The ruling, only applies to drivers in California, which is Uber's biggest market. However, California is is just a fraction of its nearly one million drivers in 58 countries and 113 cities.

San Francisco Uber driver Barbara Ann Berwick​ drove for several months in 2014 and filed the suit last September, according to Reuters. 

The ruling could potentially upend Uber's business model, if other states adopt the same policy.

An employee vs. a contractor

We'll start with the basics: what's the big distinction between an employee versus a contractor or freelancer? The Internal Revenue Service has an entire section dedicated to determining whether or not a person is an independent contractor or an employee. In terms of taxes, an employee will receive a W-2 and a freelancer will get a 1099 tax form. Employees are often eligible for benefits, workers compensation insurance, and the ability to collect unemployment.

"The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done," the IRS explains on its website.

"You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done)," the website later explains. "This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed."

How does this apply to Uber?

Uber deems its drivers independent contractors, claiming that it is a logistics company that merely provides the software to connect the driver to the rider -- connecting the dots between supply and demand. Like independent contractors, Uber drivers set their own hours and schedule, can log off and on as they please, and are not required to pick up a passenger.

However, some like Boston-based attorney Shannon Liss-Riordan, have argued that because of Uber's strict rules for drivers (such as required screening and training as well as the potential to be terminated for getting below a rating of 4.6 stars) drivers act more like employees than contractors. A 20-point test from the State of California's Employment Development Department corroborates this. 

Others, including the U.S. District Judge overseeing a case against Lyft (Uber's competitor) see the contractor vs. employee dichotomy as antiquated. “The jury in this case will be handed a square peg and asked to choose between two round holes,” U.S. District Judge Vince Chhabria wrote. “The test the California courts have developed over the 20th Century for classifying workers isn’t very helpful in addressing this 21st Century problem.”

However, the California Labor Commission ruled that Uber drivers are employees because Uber is "involved in every aspect of the operation" -- connecting the driver with the customer, tracking the route, payment transaction, and rating of service. 

What does this mean for Uber and its drivers?

Uber, which is valued above $40 billion dollars, can still operate its "independent contractor" model in other states and countries. In California, however, it will be required to pay quite a bit more to reclassify drivers as employees. A profile of attorney Shannon Liss-Riordan written by Fusion, titled "Meet the lawyer taking on Uber and the rest of the on-demand economy," spelled out the the ramifications of Uber having to switch from 1099 contractors to W-2 employees:

"[I]f Uber’s drivers were reclassified as normal W-2 employees, rather than 1099 independent contractors, Uber would be required to pay payroll taxes for them, and provide them with benefits like workers’ compensation insurance and unemployment. In some states, such as California, Uber would also be required to reimburse drivers for the costs of the job, including gas, wear-and-tear on their cars, and car insurance."

Overall Liss-Riordan paints this as a better deal for drivers, who would be more protected and have to pay less out of pocket for car maintenance.

Former U.S. Secretary of Labor Robert Reich also weighed in on his Facebook page on Wednesday, stating the following:

The rise of “independent contractors” Is the most significant legal trend in the American workforce – contributing directly to low pay, irregular hours, and job insecurity. New software technologies are allowing almost any job to be divided up into discrete tasks that can be parceled out to workers when they’re needed, with pay determined by demand for that particular job at that particular moment.

Some workers prefer to be independent contractors because they like the flexibility. Mostly, though, they take these jobs because they can’t find better ones. And as the race to the bottom accelerates, they have fewer and fewer alternatives. The "share economy" is bunk; it's becoming a "share the scaps" economy.

It remains unclear how California's ruling will affect Uber riders as well if the company will change its business model or rates. It is also likely that Uber will appeal this decision, which would delay the implementation of this employment reclassification. ATTN: has reached out to Uber for comment, and will update this story accordingly. Read the decision below: