California Businesses Need to Review Classification of Independent Contractors to Ensure Compliance with New Gig Worker Law
Beginning January 1 of this year, California businesses must comply with new legislation making it significantly more difficult for them to use the independent contractor designation to avoid the expenses involved in providing employee benefits.
The law, California Assembly Bill 5 (AB 5), will require many businesses to reclassify their California-based independent contractors as employees. Because many of those affected participate in California’s gig economy, the law is also known as the “Gig Worker Law.” The law does not apply to out-of-state independent contractors.
Since much of the AB 5 discussion has focused on technology-based services like Uber, Lyft and Grubhub that have used the independent contractor designation to avoid providing benefits to their workers, many business owners have not accounted for the fact the legislation has fundamentally altered how the state defines an employee. In fact, the AB 5 provides that all workers are presumed to be employees unless an employer can prove otherwise.
AB 5 marks a significant change to California’s employment landscape. Therefore we strongly suggest you review your relationship with your independent contractors to ensure your business is not required to reclassify them. Failing to do so can get expensive. AB 5 allows for civil penalties of up to $25,000 per violation if an employer has found to have willfully misclassified an individual as an independent contractor.
The ABC Test for Independent Contractors
AB 5 codifies the test laid out by the California Supreme Court’s 2018 decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, known as the “ABC test,” to determine whether a worker should be classified as an independent contractor or an employee. Under the test, a worker may be classified as an independent contractor if he or she meets all of the following conditions:
- Operates free from the control or direction of the hiring company. This means the hiring company cannot exercise control or direction over the worker’s services. Essentially, this limits a business to either accepting or rejecting the work with no say in how that work is performed. This test is often used by the IRS to determine worker status.
- Performs a specialized service that is outside the hiring company’s usual business. The worker must not be performing the work that would normally be done by the hiring company’s employees. That means the worker cannot be performing services related to the hiring company’s core business.
- Performs the work as part of an independently established trade, occupation or business. The worker’s business activity must exist independently of his or her relationship with the hiring company. It must be an enterprise that will survive the termination of the relationship with the hiring company.
Those workers who do not meet all three prongs of this test must be classified as employees, even if that worker still qualifies as an independent contractor for federal tax purposes or for the purposes of the Affordable Care Act.
A business’s decision to classify a worker as an independent contractor may be reviewed by the California Labor Commissioner, Franchise Tax Tax Board, the Employment Development Department, and other state agencies. AB 5 also allows California’s attorney general, some city attorneys, and local prosecutors to take legal action against companies they believe have misclassified workers as independent contractors. Finally, workers may bring a class action against a hiring company for violations of AB 5.
Some Workers Exempt from ABC Test
AB 5 specifically exempts a number of job categories from the ABC test. Those categories include:
- Physicians, surgeons, psychologists, podiatrists, dentists, and veterinarians;
- Insurance brokers;
- Engineers and architects;
- Private Investigators;
- Registered investment advisors and securities brokers; and
- Salespeople who are not paid by the hour.
However, even workers who fall into those exempt categories will still be required to qualify as independent contractors under the test the California Supreme Court laid out in Borello vs. Dept. of Industrial Relations.
The Multi-Factor Borello Test
According to the California Department of Industrial relations, the Borello test relies on multiple factors to make the determination of whether a worker may be classified as an independent contractor. Those include whether the hiring entity has all the necessary control over the means and the manner of accomplishing the desired work, even if the control is not direct, exercised or explained.
However, the control factor is not definitive. The department said it must be weighed alongside other factors, including:
- Whether the worker holds himself or herself out as being engaged in an occupation or business that is distinct from the employer;
- Whether the work is an integral part of the employer’s business;
- Whether the employer provides the tools, supplies and location for the individual to do the work;
- Whether the worker has invested in the equipment and materials necessary to perform the task;
- Whether a special skill is required to perform the service;
- The type of occupation and whether the work is typically done under the direction of an employer;
- The worker’s potential for profit or loss;
- The length of time for which the work must be done;
- The permanence of the working relationship;
- Whether the worker is paid by the hour or by the job;
- Whether the worker hires his or her own employees for the job;
- Whether the employer has the right to fire the worker, or whether such an action would be a breach of contract; and
- Whether the worker and employer believe they are creating an employer-employee relationship.
The Broello test requires the consideration of all relevant facts and no single factor controls the determination of whether a worker is an independent contractor or an employee. Different courts have emphasized different factors when applying the test.
Professional Services Workers Exempt from ABC Test
Workers who provide certain professional services may be classified as independent contractors under AB 5 if they qualify under Borello and meet certain additional conditions. The following are listed in the statute as eligible for the professional services exemption from the ABC test :
- Marketing professionals producing original and creative work;
- Travel agents;
- Human resources administrators who do work that is predominantly intellectual and varies in character;
- Graphic Designers;
- Grant writers
- Fine artists;
- Enrolled agents;
- Payment processing agents operating through independent sales organizations;
- Photographers who provide no more than 35 submissions to a hiring entity each year; and
- Freelance writers, editors and newspaper cartoonists who provide content to a hiring entity no more than 35 times each year.
Those eligible for the professional services exemption must also meet the following criteria to be classified as independent contractors:
- Maintain a separate business location;
- Have a business license;
- Are able to set or negotiate their own rates;
- Set their own hours;
- Be engaged in the same type of work under a contract with another firm or offer similar services to other customers; and
- Regularly exercise independent judgment when performing services.
Real Estate Licensees and Repo Agencies
The Business and Professions Code provides that real estate brokers and real estate salespersons that are licensed under the broker may negotiate a contract that designates the salesperson as either an independent contractor or an employee. AB 5 did not alter that provision but it does stipulate that If the code is not applicable, then the Borello test applies for the purposes of applying the Labor Code to that worker. The statutorily imposed duties of a broker are not factors to be considered when applying the test.
AB 5 also does not alter the determination of whether a licensed repossession agency is an independent contractor or employee under the Business and Professions Code when the agency is free from the control of the direction of the hiring entity in the performance of the work.
Additional Contractors Exempt from the ABC Test
AB 5 allows businesses to classify types of workers who provide professional services as independent contractors if they meet the often-lengthy list of criteria listed in the legislation and satisfy the Borello test. The types of workers, and the criteria that must be satisfied, are listed below.
- Business-to-business contractors. While the
other listed exceptions only apply workers performing the specified service,
this exception may be applied to any worker meeting the listed criteria.
Additionally, the business-to-business contractor exception applies to
individuals conducting business as a sole proprietor, partner operating in a
partnership, member of a limited liability company, or corporation that meet
all 12 of the following conditions:
- Is free from the control and direction of the hiring entity while the work is performed;
- Provides services only to the hiring entity and not the customers of the hiring entity;
- Provides services under a written contract;
- Possesses the proper business licenses or a business tax registration;
- Operates from a business location that is separate from that of the hiring entity;
- Is usually engaged in an independent business of the same nature as the work being performed;
- Has contracts with other entities to provide the same or similar services being provided to the hiring entity and is not restricted from working for other entities;
- Advertises or offers services to the general public that are the same, or at least similar, to those provided to the hiring entity;
- Provides the tools, vehicles and equipment needed to perform the contracted-for services;
- Negotiates rates with the hiring entity;
- Is able to set the hours and location for the work, if the nature of the work allows for it; and
- Is not performing work that requires a license from the Contractor’s State License Board.
- Construction subcontractors. A subcontractor
working for a contractor in the construction industry qualifies as an
independent contractor if he or she meets the following criteria:
- Has a written subcontract;
- Holds a subcontractor’s license issued by the Contractor’s State License Board and is performing work within the scope of that license (unless the subcontractor is providing construction trucking services);
- Possesses all of the necessary business licenses or a business tax registration;
- Maintains a business location that is separate from that of the contractor;
- Has the authority to hire and fire the persons who provide or assist in providing the contracted for services; and
- Assumes financial responsibility for errors or omissions in the contracted for work or services.
- Businesses obtaining work through referral agencies. Businesses obtaining work through job referral agencies are
independent contractors working for the agency if certain conditions are met.
This designation applies to workers who provide clients with graphic design,
web design, photography, event planning,
tutoring, moving, minor home repair, house cleaning, errands, furniture
assembly, animal services, dog walking, dog grooming, picture hanging, pool
cleaning, and yard cleanup services. Under AB 5 those businesses must meet the
following 10 criteria to be an independent contractor:
- Is free from the control and direction of the referral agency, both under the contract and as a matter of fact, while working for the client;
- Has the required business license or a business tax registration;
- Is in possession of the state contractor’s license if one is needed;
- Operates under the service provider’s name, not the name of the referral agency;
- Provides its own tools and supplies;
- Is usually engaged in an independently established business providing services of the same nature as those supplied the client;
- Is not subject to any client restrictions and is free to seek work elsewhere or through a competing agency;
- Sets its own terms and hours and the client is free to accept or reject clients or contracts;
- Sets its own rates and is not subject to deductions by the referral agency; and
- Is not penalized for rejecting clients, unless the service provider fails to fulfill its contractual obligations.
Finally, commercial fishermen on U.S. vessels are exempt from the ABC test until January 1, 2013.
AB 5 Enforcement Questions Remain
It is still not known how the courts will choose to interpret AB 5. The law is already being challenged by Uber and other companies and legal experts have noted that since the Supreme Court issued its Dynamex ruling, the court has not applied all three prongs of the ABC test in any one case. That means it is still possible the law will be interpreted in a manner that allows companies some flexibility when it comes to classifying workers as independent contractors.
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This post was written by Sean Allaband