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- California Assembly Bill 5 (AB5) went into effect on January 1, 2020, and it requires employers to adhere to a stricter definition of ‘independent contractor.’
- If a worker is incorrectly classified, there can be significant fines as penalties — which can range from $5,000 to $25,000.
- All California-based businesses or companies that do business in California should evaluate their contractors against the ABC test.
- If the contractor does not meet all three parts of the ABC test, they can either try to change the current work arrangement so they can be classified as an independent contractor or become an employee.
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California Assembly Bill 5 — most commonly referred to as AB5 — went into effect on January 1, 2020.
At its core, the main purpose of AB5 is to ensure employers correctly classify their workers and remain accountable to a stricter definition of ‘independent contractor.’
To comply with AB5, every worker — excluding those in exempt occupations like healthcare professionals, investment advisors, and direct salespersons — is now subject to the ABC test. If they meet all three qualifications, they’re considered an independent contractor. If they don’t, they must either be transitioned to employee status or the work arrangement has to change.
The intention of the bill is to prevent employers from taking shortcuts to save money — nationwide, incorrectly classifying independent contractors resulted in over $44 billion in unpaid taxes from 2008 to 2010 — and to provide workers whoshouldbe classified as employees with the rights they deserve, such as healthcare, workers’ compensation, paid time off, disability leave, and more.
While some workers will benefit greatly from the passing of AB5, others hope to remain independent for a number of reasons. And, many companies aren’t too happy with the bill, either.
Rideshare behemoths Uber and Lyft claim that AB5 could send them into bankruptcy. Their two million drivers are all independent contractors — making them full-time employees would be financially devastating.
Uber, Lyft, Postmates (an on-demand delivery company), and a few more similar companies proposed a measure for California’s 2020 ballot. They hope voters will choose to protect companies like them from the law.
If you’re a California business — or do business in California — you should do everything you can to make sure you’re compliant with AB5. If you don’t, there could be significant penalties.
“Business owners need to be mindful that the Franchise Tax Board will be auditing businesses going forward, and they can collect the back payroll taxes owed, plus interest, fines, and penalties,” explained Emily D. Baker, a California-based lawyer and host of the “Get Legit Law and Sh!t” podcast.
And according to Baker, these aren’t meager fines by any means. For each worker who is misclassified, the employer can be fined anywhere from $5,000 to $15,000. And, if they find that you have a habit of doing this, that range is bumped up to $10,000 to $25,000.
Here are the steps you should take as a small or large business that employs contractors and freelancers in California.
First and foremost, you — and all members of your leadership team — need to familiarize yourself with the law. Don’t hesitate to consult with an employment lawyer to help you understand the ins and outs of it. And if counsel isn’t in the budget, there are other options, too.
“Small business owners with particularly limited in-house resources don’t have to tackle complex compliance issues all on their own,” explained Michael Cole, employment counsel at Gusto, a California-based payroll, HR, and benefits platform. He added that there are many affordable online resources that can help.
“As business owners consider HR technology, it’s important to look for solutions that offer tools, features, checklists, and templates designed to keep them on track when it comes to compliance,” Cole shared. “Additionally, some may want to consider a platform that includes support from certified HR professionals.” Some additional HR tools like Gusto you could consider are: Zenefits, ADP, Rippling, and Workday HCM, among others.
Whether you’re doing it on your own or having someone help you, you need to analyze the role of every single independent contractor you employ.
First, check to see if they’re exempt. (A list of exempt occupations is included in the text of the bill.) Even if they are exempt, they’re still subject to the Borello test, which has 11 parts. Unlike with the ABC test, in which all three parts must be met, no single item of the Borello test is determinative. The main goal is to ensure that workers control when and how they do their work. If they don’t pass the Borello test, then you can consider the same options you have for non-exempt workers who don’t pass the ABC test.
The ABC test includes the following three criteria:
- The worker must be free from the hiring company’s control in how and when they do their job.
- The worker must perform work outside of the hiring company’s core business.
- 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.
In regards to what a company’s core business is, Elliot Dinkin, president and CEO of Cowden Associates, a compensation, health and benefits, and retirement consulting firm, said, “Core business is one that’s central to generating the larger share of revenues and is instrumental to the primary function of business.”
Uber, for example, currently doesn’t pass AB5 because transportation is considered part of their core business. Without drivers, transportation by car is hard. (Though they are still working hard on self-driving cars). The rideshare giant, however, argues that their core business is providing the software that drivers and riders leverage.
Be very well prepared to prove and back your reasoning in case you get audited.
“Strengthen your position to ensure solid footing exists and enforce your position through communications, operations, and related activities,” Dinkin said.
One way to do this is by requiring all of your contractors to present solid evidence that they’re an independently established corporation. Encourage them to create an easy-to-search website for their business, clearly stating how they can be contacted and providing a list of clients they’ve worked for or are currently working for (with each client’s permission, of course).
For freelancers — writers, designers, editors, and so forth — keep close track of how many pieces each one has submitted throughout the year. With the passing of AB5, freelancers can no longer submit more than 35 pieces to a single publication within one year. If they do, they are technically considered an employee. Establish an internal tracking system, and encourage your freelancers to keep track, too. On each submission and/or invoice, for example, they could note what number submission it is (“4/35 for 2020,” for example).
In addition, “communicate clearly with [your freelancers] to make sure they’re clear on what counts as a submission,” explained Baker. You need to be clear, for instance, if a multi-piece story is one submission or more, in addition to specifying how many rounds of edits a single submission includes.
“Clear internal policies will put publications in the best position to defend themselves if they’re audited over AB5,” Baker said. “You can’t go wrong with documentation and clear communication.”
If one of your independent contractors doesn’t meet all three parts of the ABC test, something needs to change. Here are two paths you can choose from:
1. Make changes to your work agreement
Look at the parts of the ABC test that the contractor didn’t meet. Are there any changes you can make to your current work arrangement that will allow them to be classified as an independent contractor?
For instance, if they didn’t meet part A because you tell them certain hours and days they have to work, can you relinquish some control? Perhaps they still do the same work, but they choose when they complete it — you just tell them the deadline.
Or, say they didn’t meet part B because part of their work is considered core to your business. Can those tasks be redistributed to a current employee, leaving the contractor with responsibilities that aren’t critical to the business?
If a freelancer you employ currently doesn’t classify as an independent contractor because they submit more than 35 projects a year, you’ll need to decrease their number of assignments (and make sure to track them!).
Again, it’s wise to consult with an expert (or leverage some HR technology) for this. You want to make sure that any changes you make to properly classify someone as an independent contractor are actually compliant.
2. Reclassify them as an employee
If the above isn’t possible, or if the independent contractor isn’t open to having their type or amount of work changed, consider making them an employee.
However, “[you’ll] need to factor in the costs and logistics of doing so, particularly when it comes to increased wages and benefits,” explained Cole. And, prepare yourself for any questions and pushback your independent contractors may have.
“Some contractors who are reclassified may not welcome the change, while others may ask about whether they’ll be paid some form of back pay or other compensation for previously being treated as a contractor [when they shouldn’t have been],” Cole added.
Of course, reclassifying someone as an employee isn’t as simple as just checking a box. You’ll need to go through the official hiring process and figure out how much money you can dedicate to their role for salary, benefits, taxes, and other associated costs.
This is a tricky spot for many businesses to be in, but to avoid possible disastrous audit outcomes, take action as soon as possible and ensure every independent contractor you have is correctly classified. If they’re not, either readjust their role, bring them on as an employee, or part ways with them entirely.
“Organizations should strategize and build out an action plan best suited to their particular circumstances,” said Jennifer Hwang, the chief strategy officer at gig platform Tilr. “Being educated and executing on a plan to ensure compliance with the law is prudent not only for California-based businesses, but also any non-California businesses that have work being conducted or done in California.”