California businesses that rely on independent contractors for their workforce face significant compliance changes and challenges after the passage of California Assembly Bill 5 (“AB 5”), which codified the California Supreme Court’s Dynamex decision and is set to take effect on January 1, 2020. Essentially, AB 5 makes it more difficult for companies to label workers as independent contractors because the presumption is that a worker is an employee, not an independent contractor unless it can prove all three elements of the “ABC test”:
- the person is free from the control and direction of the hiring entity;
- the person performs work that is outside the usual course of the hiring entity’s business; and
- the person is customarily engaged in an independently established trade, occupation, or business of the same nature that involved the work performed.
The Los Angeles Times estimates this forced move from independent contractor status to employee status could cost businesses 20% to 30% more in operational costs when taking into account Social Security and Medicare taxes, unemployment and disability insurance, workers’ compensation, sick leave, minimum wage, overtime, rest breaks, and protections against discrimination and sexual harassment.
But misclassification would be a costly move too. The Labor Code authorizes the state Labor and Workforce Department Agency to assess civil penalties between $5,000 to $15,000 for each misclassification, plus any unpaid taxes. That means that it could easily cost a business a lot more if it is caught misclassifying workers than if it had paid workers as employees.
More than 50 industries and types of businesses successfully lobbied to be exempted from the ABC test in AB 5. Instead, these industries and businesses are covered by the multi-part test established by the California Supreme Court in the Borello case from 1989. These exemptions include the following:
- Licensed insurance agents;
- Physicians and surgeons, dentists, podiatrists, psychologists, and veterinarians;
- Lawyers, architects, engineers, and accountants;
- Securities broker-dealers, investment advisers, direct salespersons, private investigators, and commercial fishermen;
- Marketing contractors, human resources administrators, travel agents, graphic designers, grant writers, fine artists, enrolled tax agents, payment processing agents, still photographers, photojournalists, freelance writers, publication editors, and newspaper cartoonists who can meet all of six specific requirements;
- Licensed real estate salespersons, repossession agents, estheticians, electrologists, manicurists, barbers, and cosmetologists;
- Business-to-business contractors (i.e., vendors) that meet all of 12 specific requirements;
- Selected construction subcontractors and motor club service providers; and
- Referral agencies connecting clients with service providers that meet all of 10 specific requirements in the following industries: graphic design, photography, tutoring, event planning, minor home repair, moving, home cleaning, errands, furniture assembly, animal services, dog walking, dog grooming, web design, picture hanging, pool cleaning, and yard cleanup.
The law does not contain any exceptions for the franchisor/franchisee relationships. Even for the exempted industries and business types, California companies will have to review their workforce and myriad legal and technical issues to determine how to comply with the new labor law to ensure that their independent contractor relationships are structured, documented, and implemented correctly by January 1.
Visit the Poster Compliance Center website to learn more about California labor laws that affect your business.