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Worker Classification Issues

Helping Taxpayers Throughout California

Rex Halverson

On Sept. 18, 2019, California’s Assembly Bill 5 (AB5) was signed into law, reclassifying millions of independent contractors in California as employees effective January 1, 2020. Known as the “gig worker bill,” much of the discussion around AB5 has centered on how it impacts Uber and Lyft drivers. However, AB5 is much farther reaching with the potential to affect virtually every company in California that makes use of independent contractors.

AB5 is a further clarification of the 2018 California Supreme Court case Dynamex Operations West, Inc. vs. Superior Court of Los Angeles (4 Cal.5th 903). This case held that there is a general belief that most workers are, in fact, employees and should be classified as such. Furthermore, Dynamex placed the burden of proof on hiring entities to demonstrate that a worker is in fact an independent contractor pursuant to a rigorous three-part “ABC Test”. This ruling and the AB5 legislation now require businesses to use the ABC Test when determining if a worker is an employee or an independent contractor.

ABC Test Criteria

A worker is presumed to be an employee, and the burden to demonstrate their independent contractor status is the responsibility of the hiring company. To do this, a company must demonstrate that the worker satisfies all three criteria of the ABC Test.

A worker may only be classified as an independent contractor if:

(A) The worker is free from control and direction of the hiring entity in connection with the performance of the work;

(B) The worker performs work outside the usual course of the hiring company’s business; and,

(C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

This new definition of an independent contractor is narrower than the previously used standard in California, the multi-factor Borello test. That test made it much easier to classify workers as independent contractors.  Whereas the reach of the Dynamex decision was limited to IWC Wage Order violations, AB5 expands the reach of the ABC Test to violations of the Labor Code and also for purposes of unemployment insurance and workers’ compensation.

Who is exempt from AB5?

AB5 provides an exempted list of workers who are not affected by the ABC Test.

Those who are exempt include:

  • Doctors, dentists, and veterinarians;
  • Lawyers, engineers, architects, private investigators, and accountants;
  • Investment advisers, securities broker-dealers;
  • Human resources administrators;
  • Travel agents;
  • Marketers, graphic designers, fine artists, grant writers, certain photographers or photojournalists, and certain freelance journalists, writers, and editors.

Some additional classifications of exemptions have certain conditions. For instance:

  • Commercial fishermen are exempt from all requirements but unemployment insurance;
  • Estheticians, manicurists, barbers, stylists, and cosmetologists are exempt but only if they make their own rates, are paid directly by clients, schedule their own appointments, and follow other requirements more akin to independent workers than employees;
  • Salespersons are exempt, but their pay has to be based on actual sales rather than referrals or wholesale purchases.

Implications of AB5

Several immediate changes are expected when AB5 takes effect on Jan. 1, 2020.  As companies have to reclassify contractors as employees and pay them legally required benefits, employer costs will increase. Some industries, such as health care and journalism, may experience a worker shortage due to the loss of flexibility in employment that will come from the reclassification.

Furthermore, businesses that refuse to reclassify employees are likely to experience numerous legal challenges from both public and private sources. These challenges will result in relatively prompt capitulation by small businesses, which cannot afford to fund protracted litigation.

For larger companies, including gig-economy corporations like Uber and Lyft, litigation over the classification of workers is likely to occupy many attorneys, arbitrators, and judges in the coming years. Some analysts believe other states will follow California’s lead and enact laws similar to AB5.

All businesses in California will need to examine their independent contractor relationships through the lens of the new framework created by AB5. Businesses must use the ABC Test (or the Borello multi-factor test if hiring for an exempt occupation) or risk litigation by individual workers claiming to be employees or class action lawyers representing workers on a collective basis.

Companies should closely follow how this new law develops as numerous categories of workers are just beginning to organize and lobby for exclusion or exemption from the employee classification. Businesses need to revise their existing independent contractor agreements and policies to more clearly adhere satisfy the ABC Test.

How do I plan for AB5?

Now is the time to start planning for how worker classification will change under AB5. Talking to an experienced California employment lawyer will help immensely. AB5 will have a significant impact, both inside and outside California. However, it’s unclear how the law will be interpreted and applied so remain ever alert to amendments by the Legislature and the courts.

If you operate a business in California, consider taking the following steps:

1. Consult an Experienced California Employment Attorney

Also consult with a California tax professional who has knowledge and experience with the independent contractor versus employee issue. Make sure you find a tax professional who has a thorough understanding of the details and nuances of AB5 and the Dynamex decision and can advise you on how you might strengthen your case that your workers are in fact independent contractors.

2. Assess Your Risk

Conduct a self-audit of your workers that are classified as independent contractors. A comprehensive self-audit should include:

  • A review of the workers’ contractual terms
  • Engagement guidelines
  • Independent contractor incorporation requirements
  • Pay rate negotiations
  • Documentation processes
  • Work structure and level of control
  • Staff and independent contractor interactions

3. Utilize Technology

Technology can assist you in structuring your business’ relationship with independent contractors as a way of decreasing risk. A platform and managed service provider can help you with risk assessment and also provide guidance on the best practices specific to your industry, the independent contractor relationship model, and changing regulations.

4. Create Separation from Independent Contractors

Establishing a business-to-business relationship with independent contractors is one of the most effective ways to stay compliant. AB5 exempts business-to-business contractors from the ABC Test as long as they meet a set of 12 criteria, all of which demonstrate that the contractor operates as their own business entity.

Contact Us

To learn more about AB5 and how you can prepare your company to comply with its requirements, call Rex Halverson and Associates at 916-444-0015 or email us at rhalverson@halversontax.com today to schedule a free initial consultation.