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Do you classify employees correctly? California’s law got stricter

AB5 is a new independent contractor law in California – signed by Governor Gavin Newsom in September 2019 – which sets rules on how workers can be classified as either employees or independent contractors (IC). It went into effect on January 2020.

Nikoletta Bika
Nikoletta Bika

Nikoletta holds an MSc in HR management and has written extensively about all things HR and recruiting.

The AB5 bill codifies the decision of the Supreme Court’s ruling in the case of the company Dynamex. In general, this law makes it harder for companies to misclassify employees as ICs, and thus obliging them to provide their workers with all benefits attached to employee status by California’s Wage Orders (e.g. minimum wages, rest breaks).

Please keep in mind: Workable is not a law firm. This article is meant to provide general information and should be used as a reference. It’s not a legal document and doesn’t provide legal advice. Neither the author nor Workable will assume any legal liability that may arise from the use of this article. Always consult your attorney on matters of legal compliance.

What constitutes an independent contractor in California according to AB5?

Until now, workers would be classified as ICs via the Borello test (S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989)). After AB5 goes into effect, companies and courts will mainly use the “ABC test” to properly classify workers.

The ABC test has three qualifiers, each of which have to be satisfied in order for someone to be classified as an independent contractor. A worker can be an IC if:

(A) they’re free from the control and direction of the hiring entity in connection with the performance of their work; and

(B) they’re performing work that is outside the usual course of the hiring entity’s business; and

(C) they’re customarily engaged in an independently established trade, occupation, or business.

Workers are presumed to be employees, unless a company can prove otherwise via this test that a worker qualifies as an IC.

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Exemptions to the AB5

The law exempts several professions including but not limited to the following:

  • Licensed insurance agents, lawyers, architects, engineers, private investigators, or accountants
  • Certain licensed health care professionals, such as physicians, surgeons, dentists, podiatrists, psychologists, or veterinarians
  • Securities broker-dealers or investment advisers
  • Direct sales salespersons
  • Commercial fishermen working on an American vessel

However, these exemptions from AB5 apply only to the ABC test. This means that an exempt worker still has to pass the Borello test to be classified as an IC.

Contracts for some professional services are exempted from the ABC test, too, but there are some additional factors that need to be satisfied along with the Borello test. These factors are clearly listed in AB5. “Professional services” in this case includes some creative professions (e.g. designers, writers, fine artists), travel agents and more.

There are other exemptions as well, so consult an attorney to get comprehensive information as needed.

Do independent contractors have any rights?

Yes. ICs have full control over how, where and when they work. They charge their own rates and aren’t bound to one employer. This flexibility is a strong motivation for workers to become independent contractors.

On the other hand, independent contractors aren’t entitled to unemployment insurance, workers’ compensation claims, minimum wage, overtime pay, rest breaks, working condition standards, and other benefits and privileges that traditionally are seen – or in some cases that are required by law – in full-time employee status. Consequently, many gig workers don’t have the leverage to negotiate their pay or living conditions, so, as misclassified employees, they are compromised.

Under AB5 law, these workers may benefit. And, the law will also protect companies that usually employ workers as employees against competitors that are trying to cut costs by misclassifying employees as independent contractors.

But, the road to AB5 is no bed of roses

The controversy around employee vs. contractor has lasted for decades. For example, the IRS once audited Microsoft for open tax years 1989 and 1990 and found the tech giant had misclassified its employees as freelancers. In 2013, the IRS estimated that employers misclassify millions of workers. Before Dynamex, there were many relevant cases in recent years – for example, the company Uni Floor had to repay significant sums in back pay in 2017 because of misclassifying its workers. On the flip side, in 2018, delivery company Grubhub won the case against one of its delivery drivers who the court found was properly classified as an independent contractor.

All that aside, AB5 is expected to have an impact on companies that consistently depend on independent contractors. That’s because the ABC test is stricter than the Borello test and its three conditions are much harder to satisfy. Hundreds of thousands of workers in California could be reclassified and many companies are likely to see a jump in employment costs.

Some employers object

The expected increase in costs is mainly why many employers are campaigning against AB5. For example, trucking company Western States Trucking Association (WSTA) had filed a federal lawsuit against AB5 which was dismissed in early 2019. Gig companies Uber, Lyft, and DoorDash started working on a ballot initiative for 2020 that will cost around $90 million. Their purpose is to earn an exemption to the law, providing some benefits to their independent contractors as a compromise.

But, their efforts have drawn fire – in a Vox article on the topic, Art Pulaski, executive secretary-treasurer of the California Labor Federation said:

“No corporation should be above the law, no matter how much they spend on political campaigns to rig the rules in their favor.”

The outcome of this campaign remains to be seen.

What could an employer do to comply with the law?

If you have even one independent contractor in California, you need to pay attention to the AB5’s requirements. Consult a legal expert who specializes in employment law in California – and make sure not to misclassify them (um, pardon the jest).

With their guidance, you can learn whether some workers as exempt or not, and you can start auditing your employment relationship with your independent contractors to determine whether the ABC test is satisfied. If it’s not, you need to change your workers’ status to employees as soon as possible.

If you’re interested in this, you’ll also want to know about other recently enacted laws in California, such as the CCPA. See a basic CCPA FAQ and a comparison of CCPA vs. GDPR.

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