With the recent rise in the number of companies using independent contractors rather than hiring more full time employees, many business owners' have been tracking possible relevant changes in employment law. Thanks to California’s new Assembly Bill 5 (AB5), which was passed in September 2019 and went into effect on January 1, 2020, businesses all across the state are trying to navigate the new restrictions regarding employing independent contractors. Due to these new restrictions, AB5 is making it more difficult for companies to classify team members as independent contractors.
Why does AB5 matter?
Depending on your role within a company (i.e. business owner, employee, independent contractor), you may have different opinions on this new employment law. The significance of classifying an individual as an employee rather than an independent contractor includes the many protections only employees are entitled to, whereas businesses are not required to provide the same benefits to independent contractors.
This includes:
- Protections under workplace discrimination laws;
- Eligibility for overtime pay;
- Protections under workers’ compensation laws;
- Eligibility for unemployment benefits following a termination;
- Coverage under employee health insurance and other benefits, including sick days, paid vacation time, and the option for a 401k
Due to the language used in Assembly Bill 5, when it went into effect on the first of the year, the new law caused many independent contractors, who were previously ineligible for the above benefits, to now be eligible and entitled to them.
The ABC Test of Employee Status
It can be difficult to determine whether a worker can be considered an independent contractor or whether they must be treated as an employee. To help business owners, employees, and independent contractors alike, the California Supreme Court set forth a three-part test, which is commonly known as the “ABC Test”. Assembly Bill 5 confirmed the ABC Test, allowing that a worker is “properly considered” an independent contractor only if they meet each of three points of criteria:
(A) “The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact.”
(B) “The worker performs work that is outside the usual course of the hiring entity’s business.”
(C) “The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.”
There are many nuances to this new law, and it effects various industries differently.
How should I prepare in light of AB5?
Assembly Bill 5 defines an “independent contractor” very narrowly, which means that any business which does business in California and employs independent contractors will want to ensure it takes the necessary steps as soon as possible. Ideally, these steps would have been completed prior to the date AB5 went into effect on January 1, 2020, however it is not too late to ensure your business is compliant with all necessary employment laws.
If you are a small business who employs workers as independent contractors, it is time to begin working with an employment lawyer if you do not already. Bringing an expert on to help you analyze your team is a must to avoid common mistakes and any penalties those mistakes may bring about. The attorney will also be able to assist you in understanding why and how to reclassify any workers who are erroneously misclassified.
After reviewing the ABC Test and reading through Assembly Bill 5, you may realize that some of your team members which are currently classified as independent workers should actually be classified as employees. While this situation is not ideal, it is better late than never, and you should take steps to make it right as soon as possible.
If you find yourself in this situation, here’s a step-by-step to get your business back on track:
- Have the worker complete an employment application if they haven’t already;
- Walk the worker through your normal onboarding procedure for employees, possibly including a background check and drug test;
- Collect the necessary information to complete an 1-9 and a W-4 for taxes;
- Enroll the worker-turned-employee in your employee benefits program;
- Register the employee with the necessary agencies requried by the state (i.e. workers’ compensation and unemployment coverage); and
- Add the employee to your payroll.
When any significant changes are made to a business, it is important to consider any further changes which may need to be made as a result. For example, once the worker has been correctly classified as an employee, they will need a company-approved system for tracking their time for payroll and overtime purposes. They should also be given an employee handbook so they are fully aware and understand the changes and what will now be expected for them to be successful.
You may want to consider requesting your employees to set permanent schedules rather than allowing them to work whenever they would like, as is common with independent contractors. This may help avoid workers-turned-employees accidentally working too many hours, resulting in unnecessary overtime hours.
What should freelancers do in response to AB5?
In response to AB5, many freelancers in California who previously operated as sole proprietors are rushing to form limited liability companies (LLCs), in hopes that the "business-to-business" exemption under AB5 will allow them to continue to control their own hours flexibility, and all the other benefits that come from being your own boss.
While businesses must be a registered business to qualify for this exemption under AB5, it is not the only consideration. The details of the individual's work and how it is directed and controlled by the party hiring them will still determine whether the individual is acting as an independent contractor.
The most significant, one-size-fits-all take-away, is that unregistered sole proprietors will NOT fall under the business-to-business exemption. Best practices are likely to consider forming an LLC or corporation, after seeking the advice from a California employment lawyer, and ensuring the details of your projects will not violate other components of the ABC test.
How does AB5 directly affect me?
Whether you are a business owner or an independent contractor, this new bill all boils down to flexibility. Many independent contractors are drawn to this work rather than a typical full time job because of the time and workplace freedom and flexibility it offers. On the other hand, business owners often employ independent contractors for the same reasons, as well as having the ability to not offer certain benefits to its workers, such as overtime pay or paid vacation time.
However, Assembly Bill 5 could take that all away by requiring that many people previously working as independent contractors to be reclassified as employees. Unfortunately, both services providers and those seeking their services could suffer time and financial freedom due to these employment law changes.
