Employment Law, Hiring Employees, Small Business

California's Assembly Bill 5 (AB5): What Business Owner's Need to Know

October 25, 2019October 25, 2019
California's Assembly Bill 5 (AB5): What Business Owner's Need to Know

On September 10, the California legislature signed a bill that could dramatically change the employment landscape of the Golden State.  The new law, Assembly Bill 5 or AB5, redefines exactly what it means to be an “employee” in California.  As most business owners know, not all everyone performing work for a company is an employee of that company.  Depending on the industry or business model, may owners use independent contractors instead.

While there are many advantages to hiring traditional employees, contractors can offer a lot of flexibility for both the company and the contractor.  This is where AB5 comes into play.  The newly-signed legislation legally redefines the requirements for classifying a worker as an independent contractor.  Importantly, it’s the responsibility of the employer to determine the status of their workers.  State lawmakers try to define the difference between employee and contractor, and employers make their best guess of classification in accordance to the most recent legislation, such as AB5. 

Experts believe that AB5 will make it significantly more difficult to classify workers as independent contractors.  In-fact, many anticipate the bill will cause thousands of independent contractors to be reclassified as traditional employees.  

Some of the more high-profile companies affected by this bill include the so-called gig-based (or app-based) economy companies, but it will also have dramatic affects on any company that relies on independent contractors.  These are companies that hire workers as independent contractors, who then work strictly through a remote platform, essentially eliminating all costs associated with the traditional employment model.  When discussing AB5, two companies that frequently come-up are Uber and Lyft.  But as a practical matter, the new legislation could affect any business that depends on independent contractors for some or all of their business needs.

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Employees vs. Independent Contractors: What’s the Difference?

The difference between an employee and an independent contractor is subtle but highly significant.  “Subtle” in that some types of jobs have qualities of both traditional employment and non-traditional contracting, and “significant” because the classification—whether it’s correct or incorrect—will have major legal and regulatory implications.

For business owners, there’s far more responsibility associated with hiring traditional employees.  Independent contractors are—as their name implies—independent.  In-fact, contractors are often-times business owners themselves; they’re not “employed” by the businesses that they work with.  This is an important point, because it means that contractors are therefore not entitled to the benefits and protections associated with traditional employment in the United States.  

In accordance to state and national laws, U.S. employees have a certain amount of rights and benefits that employers are legally obligated to provide.  Depending on the type of business, the industry, the type of worker, the size of the business, and the state-specific regulations, these may include:

  • Workers Compensation Insurance
  • Minimum Wages
  • Unemployment Insurance
  • Long-Term Disability
  • Discrimination Protections
  • Paid Family Leave
  • Overtime Compensation

Clearly, this isn’t a nominal expense for employers.  Some businesses pay hundreds or thousands of dollars per year, per employee to provide these benefits and protections.  But most of these benefits don’t apply to independent contractors.  For this reason, businesses generally want to classify their workforce as contractors instead of employees (thereby avoiding these expenses altogether).  These costs are especially pronounced in California, a state with incredibly worker-friendly employment regulations.

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The ABC Test: Will AB5 Apply to my Business?

Most of the time, it’s clear and obvious whether a particular worker is an employee or an independent contractor.  For example, any salaried worker would be considered employed by the business that pays their salary.  Further, most hourly workers are also considered traditional employees.  However, this determination isn’t always easy.  

To establish some legal parameters to the “employee vs. contractor” determination, California courts have decided to adopt on the ABC test.  Under this test, every worker is considered a traditional employee until they can prove that:

  1. The worker is free from the control and direction of the hiring party (of course, then there is considerable debate over the term “control”)
  2. The worker performs work that’s outside the scope of the hiring party’s usual business
  3. The worker has an established track-record—ideally, their own business—in a trade that’s similar to the work being asked of them by the hiring party

These are frequently referred to as the three “prongs” of the ABC test, and all workers in the state of California are considered traditional employees until all three criteria are satisfied.  For business owners, it’s possible that a worker be considered an employee in terms of employment law, but an independent contractor for tax purposes.  It’s wise to contact a legal professional in these situations, as this can get complicated rather quickly.  

Lastly, a quick word of warning to California employers: everyday, California state officials are reviewing worker classifications on a case-by-case basis.  Businesses that misclassify workers—especially if done intentionally—are subject to fines, back payments, and perhaps litigation.  Once AB5 takes effect in January 2020, employers should rethink the classification of their current workers, consider the ABC test, and decide if aspects of their workforce should be reclassified.  

AB5 won’t automatically perform this reclassification, it is still the employer’s responsibility to determine the status of their workers.  If there’s any confusion or misunderstanding regarding AB5 or the newly-standardized ABC test, a business or employment law attorney may be of great assistance.

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