Effective January 1, 2020, California Governor Gavin Newsom signed several laws impacting California employers. One of these is Assembly Bill 5 (AB 5), which will have a long-lasting impact on the Independent Contractor Industry.
Back in 2018, the California Supreme Court issued its decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles. In Dynamex, the Court introduced a new standard to determine whether a worker is deemed an employee or an independent contractor. The standard, which is often referred to as the “ABC” test, considers pretty much all workers to be employees. In order for employers to meet the burden and classify its workers as independent contractors, they must establish each of the following three conditions:
- that the worker is free from the control and direction of hirer in connection with performance of the work, both under the contract for the performance of such work and in fact;
- that the worker performs work that is outside the usual course of the hiring entity’s business; and,
- that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for hiring business.
As one can see, it is extremely difficult to meet the above conditions and for that reason, almost all workers are considered to be employees under the Dynamex. Now, AB 5 effectively codified Supreme Court decision in Dynamex and we may assume that employers in various industries will have to reclassify their independent contractors to employees to avoid harsh consequences of misclassification.
I have had several conversations with my clients regarding the possible consequences of misclassification of employees. All it takes is one disgruntled so-called “independent contractor” to file a claim with the California Employment Development Department (EDD), claiming he or she was misclassified and your business will most likely end up in an audit. With AB 5, chances are EDD will determine that the worker was misclassified, and that determination may bring in some serious consequences to your business from penalties to back pay of employment taxes. However, the story does not end up there: once EDD completes its audit and determines the worker was misclassified and serves you with a bill, both the Franchise Tax Board and the IRS will usually adopt the EDD findings and send you their own misclassification fees. How do they know EDD determined your workers have been misclassified? Thanks to inter-agency sharing of audit results they will find out quite fast. For all of these reasons, I offer one piece of advice to my clients: when in doubt, please do classify even independent contractors as your employees. That is how your business will stay protected and you will avoid possible consequences that may even result in your business winding down.
On the other hand, AB 5 does establish certain exceptions which will cover various industries, such as:
- Doctors, surgeons, dentists, podiatrists, psychologists, or veterinarians performing professional or medical services provided to or by a health care entity;
- Lawyers, insurance brokers, architects, engineers, private investigators, or accountants;
- Securities brokers/dealers or investment advisers and their agents and representatives that are registered with the Securities and Exchange Commission, the Financial Industry Regulatory Authority or the State of California;
- Real estate agents, repossession agencies, direct-sales persons, commercial fishermen;
- Individuals performing services under a contract with a licensed “motor club.”
If the employers belongs to one of the industries above, their case will be reviewed under Borello & Sons, Inc. v. Department of Industrial Relations standard. Under this standard, the court looks at how much control employers are exerting over the workers and secondly whether workers purchase their own equipment, set their own hours, perform services for companies other than the hiring entity, and etc.
