Small-business owners have much more to lose when it comes to California’s confusing law change.
CEO of American Tax & Business Planning
5 min read
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On one side of the street were truckers, blaring horns and demanding the right to stay independent. On the other, Uber and Lyft drivers, demanding the right to become employees. This recent scene on the streets of San Francisco acted as a microcosm of the confusion and complexity that California Assembly Bill 5 (AB5) has introduced. Meant to restrain the gig economy created by Uber and Lyft, AB5 essentially makes it tougher for workers to be classified as independent contractors.
And while the law is limited for now to California, it is likely the template for legislation to come from other states around the country. AB5 has set off intense debate about what constitutes an employee, and whether the law is really about protecting workers or more about generating additional tax revenue.
Uber and Lyft are worried for obvious reasons, but it’s small businesses that should be wringing their hands the most. The highest burden of cost will fall, just like it always has, on them, not the large corporations that have not only the resources to help navigate new legislation, but a much lighter tax bill — about 21 percent compared to 28 percent for small businesses. Of course, this is a fight that’s been brewing for many years. Small-business owners have already been squeezed, and how to classify their employees is just the latest example.
Related: An Entrepreneur’s Guide to Compliance
The distinction between big and small is crystalized in the recent uptick of wage-and-hour suits, which purport workers are actually employees instead of independent contractors. Amazon might be able to withstand such a lawsuit with little to no fanfare, but this kind of litigation can put smaller companies out of business. That’s because if a court decides you treated a worker like an employee, you now owe all of the taxes you never paid on their behalf, and potentially all the cost of covering their healthcare. It can get more complicated if you’re in an industry that requires workers-compensation insurance. You could be found liable for that as well.
For example, I once had a client who ran her own massage-therapy studio. She successfully rented out unused rooms to other therapists until the day one of them suggested they were employees and demanded back taxes and wages. All it takes is one disgruntled worker to raise the red flag, and if you don’t have your affairs in order, you’re vulnerable.
It seems with each new rule designed to make it harder for companies to classify workers as independent contractors, the burden on small businesses gets bigger. The good news is there’s a lot you can do to protect yourself.
Only engage in business-to-business payments.
This is the number-one priority. Only engage with independent contractors who have gone through the process of creating their own company. That way, you’re only ever making payments to a business, not an individual. I once knew of a firm that employed a full-time lawyer whose only job was to help independent contractors set up their own businesses. While it was expensive, the cost was worth it. Even without an attorney, it’s extremely easy for individuals to set up an LLC, and can get even easier depending on what state you’re doing business in.
Ensure you’re not the sole provider of income.
To be truly independent, a contractor needs to be working on more than one project with more than one company. If you’re providing all their income, even if it’s a big job and it seems reasonable, you could get pegged as an employer. Even if you’ve got contractors on a major project, they need to be working for multiple companies to be truly considered independent.
To ensure your contract will hold up in court, you’ll need to make sure your contractor is doing their part. It’s not enough for them to tell you they secured their own insurance. You need to see the proof. Also, get your hands on some kind of proof that your contractors are paying their taxes properly, because if the IRS comes knocking on their door demanding loads of cash, it’s all too easy to point the finger back at you and claim you should have been paying employment taxes and withholding all along.
Related: The Legal ABCs of Running a Transportation Service
Decide what’s best for your business.
While getting your books, payroll and contracts in order will go a long way towards protecting yourself, there’s nothing that’s foolproof. As legislators and tax collectors begin to potentially undo the gig economy, the burden will continue to fall on small-business owners. The fact remains that they pay higher taxes and states have more revenue to gain from ensuring they’re paying up.
If, despite all these challenges, you decide to stick with independent contractors, don’t take the risk of assuming it’s a problem for the Ubers of the world. Stay up to speed on what’s happening in your state, cover your bases, and perform your due diligence in every case. It could literally mean life or death for your business.