California’s New AB-5 Independent Contractor Law – What you need to know

*Read on for COVID-19 update as it applies to Independent Contractors

I was calling my Uber X a few weeks ago (pre-Quarantine!)  when I noticed that I only saw an estimated charge and not the fixed fee as usual.  Then the penny dropped. The new Independent Contractor laws that Uber has been fighting so hard against came into effect January 2020. This, I figure, is their new way of dealing with it.

Drivers can now see their trip details upfront and reject a ride without penalty. By giving their drivers more control, Uber is hoping to keep their drivers classified as Independent Contractors.

AB-5 Independent Contractor Law

If you hire Independent Contractors in California, you need to know about AB-5!

 Assembly Bill 5 (AB-5), came into effect as Labor Code Section 2750.3 in California on January 1, 2020.

AB-5 changes California’s test for determining whether a worker is an employee or independent contractor for purposes of the Labor Code, the Unemployment Insurance Code, and the wage orders of the Industrial Welfare Commission.

As business owners, we all know that it’s preferable to use independent contractors to perform certain jobs than hire a new employee because of the savings on operational costs.  

Your company doesn’t have to withhold federal payroll taxes as you would for an employee nor does it have to withhold Social Security taxes, federal disability taxes, and federal or state income taxes. You don’t have to pay an independent contractor overtime, sick or vacation leave, minimum wage or worker’s compensation.

The pull is real, but with the passing of AB-5, business owners need to take extra precautions that they pass the test of classifying their workers as Independent Contractors.

So what’s the test? – Easy as ABC

The New ABCs of Business

Under the new ABC Test a worker is an Independent Contractor  only if all three of the following criteria are satisfied:

  1. The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the performance contract and in fact.
  2. The person performs work that is outside the usual course of the hiring entity’s business.
  3. The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Think it through before you do

You may have heard about Dynamex.  This courier company reclassified all its drivers from employee status to independent contractor status, to cut down the government agency expenses I mentioned above.

But they failed the ABC test when they got sued by some of their drivers because Dynamex was essentially a transportation service and had a hard time arguing that the drivers performed work outside of the usual course of its business.  They also couldn’t show that the drivers were free from Dynamex control and direction due to the tracking and record-keeping system the drivers were required to adhere to, and the instructions they were given by Dynamex to pick up and deliver.

Beginning to sound a lot like Uber?

It’s not what you say, it’s what you do

In the past, you may have thought that you can protect yourself by writing contracts that designate workers as independent contractors, get it signed by the worker, and believe they’re free from the consequences of misclassification.

However, look again at the ABC test.  What matters is not what you call it, but how you deal with your workers.

Do you control the behavior of the people you hire?

  1. The person is free from your control and in connection with the performance of the work, both under the performance contract and in fact.

Do you tell your workers what time to work, provide the tools and tell them how to use them? If so, they are not considered a contractor or freelancer under this new law. In fact, these are all tell-tale signs of an employee relationship.

Do they do work for you that you wouldn’t normally provide yourself as part of your business? Are they free to work for others at their own discretion, set their own hours and place of work? Then you’re good! As these are signs of an independent contractor relationship.

Is your type of business the same or related?

  1. The person performs work that is outside the usual course of your business.

Do you own a restaurant and hire workers to cook for you? It will be hard to argue that their work is separate to the course of your business.

Or do you own a restaurant and hire a graphic designer to create your menus? Probably outside the usual course of your business, making them more likely an independent contractor.

Does the person have their own business set up and perform less than 50% of their work for you?

  1. The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Do you hire a contractor to build some new table booths in your restaurant and they own a carpentry firm and knocked out killer booths for all your competitors too?  You passed with a C!

This third element should not be downplayed.  What the test is looking for is whether the person you hire has a business set up in their own name or has a professional license to conduct the type of work you’re hiring them for, and performs this type of work for others, not just you.

Apply this to our example of the graphic designer.  Does she have her own design company? Does she create menus and logos for other diners or shops in California?

Or, is she one of your kitchen staff who attends design college?  If so, hate to break it to you but, she’s probably still your employee.

What you need to know about new California AB-5 independent contractor law

Can you afford to misclassify?

If the misclassification was unintentional you could end up paying $50 for each Form W-2 that you, as the employer failed to file, penalties of 1.5% of wages you failed to withhold income taxes on, 40% of Social Security and Medicare that you didn’t withhold from the employee and 100% of the matching taxes you as the employer should have paid, plus interest.

If the misclassification was intentional, you could be looking at jail time and heavy financial penalties.  That’s right. I said jail time.

The Good News?

AB-5 exempts certain professions from the ABC Test who will in most cases not be classed as employees.  For example, licensed insurance agents, licensed health care professionals, registered securities broker-dealers or investment advisors, direct sales salespersons, real estate licensees, workers providing hair or cosmetology services, construction subcontractors, contracts for professional services, service providers.

Classify Carefully

As you can see this law is far-reaching and of significant concern for most business owners due to the heavy consequences of getting it wrong.

Make a list of all the workers you hire and run them through the ABC test.  Or use the free Independent Contractor agreement I’m giving away and ask yourself if you can complete it honestly for each worker you want to classify as an independent contractor.

If you have any doubts or questions about your classification, consider joining Equal Legal and getting an attorney to take the stress out of it as an affordable solution.

It’s far better to be 100% sure before you classify than misclassify and pay the fines.

COVID-19 – A word of Caution**

Misclassification of independent contractors has just reached boiling point due to the COVID-19 crisis we find ourselves in. It is crucial that your business is checking its ABC’s and that your filings are up to date.

California Assemblywoman Lorena Gonzalez, the AB-5 sponsor, is calling for state agencies to immediately process misclassified independent contractors as employees eligible for Unemployment Insurance. Drivers, janitors, health workers, and other gig workers also are calling for recognition of employee status, with access to paid sick leave and other benefits.

Worker's rights

“I authored AB-5 precisely for the moment we are in now,” Assemblywoman Gonazlez said.  “These Californians need our help, and EDD has the authority and legal framework to aggressively address misclassification and provide these workers with the benefits they deserve.”

Be aware that the state of California, and other states, are being called on to audit employers with workers who are presumptively eligible for UI, e.g. Uber, to make sure they’re up to date with their payroll taxes.

In times of national emergencies such as we find ourselves in under COVID-19, UI funds will be drained and the State will most likely go tough on businesses, in order to replenish funds.  Don’t let this be you.

We may also want to consider how we treat our workers. In light of COVID-19 ineligibility to sick pay, paid family leave and Unemployment Insurance became a stinging reality overnight for many gig workers and contractors.  We may want to remember that our workers are the ones who helped us build our businesses and give them credit for our success by remembering them in times of need.

If there ever was a time to make sure your books are in order, that time is now.  

For a monthly membership of $68, you can consult with an Equal Legal attorney about your classification. 

More info:

Legal support for women entrepreneurs – Equal Legal 

Nothing within this article is intended to be construed as, or used, in the place of legal advice.