Independent Contractor Versus Employee: The ABC Test for Law AB5
Working in California can be a beautiful experience: the ocean, the mountains, sunlit skies, forests, and deserts. Yet working here also has its unique challenges and complexities, including the new law AB5, codified as Labor Code 2750.3, which governs the reclassification of the independent contractor employment status here in California.
In order to try and understand this game-changing law, I brought in some experts: LeiLani E. Quiray, CEO of Be the Change HR, along with Brendan Ford and Kristopher Diulio, the legal team of Ford & Diulio, specializing in business disputes and employment issues.
Let’s get to the meat of what you need to know about this law, which is essentially how to define an employee vs. an independent contractor. Now, in the state of California, if you’re an employee, the employer has the responsibility of paying social security, payroll tax, unemployment, insurance, workers comp, etc. and complying with state and federal laws concerning wages, hours, and conditions of employment. Under this new law, who and what is now an employee versus an independent contractor becomes much more complex.
This new law sprung up from a case called Dynamex, which you should read if you own a business in California, and went all the way to the Supreme Court where its decision has birthed AB-5.
The most important thing you need to know is that there is an ABC “smell test” to determine who is an employee versus an independent contractor.
The ABC Smell Test:
A: the presumption is that a person working for someone else is an employee, and so you have to prove that they are a contractor. In order to be considered an independent contractor, a person has to be free from the control and direction of the hiring entity of the employer.
Example: so if you hire a plumber and then tell them how to fix the sink, then they come under the command of the employer (you) and subsequently lose their independence. Yet let’s say you hire someone to trim the trees in the backyard: if you tell them how to trim this tree in general, it’s probably fine, but if you start getting really specific, you start crossing a line because of that control or direction.
B: A person must perform work outside of the usual scope of the hiring entity of the employer’s business. So if I run a plumbing business, and I hire someone to fix a sink, then that person is in the same business, they are an employee. If I am a florist, and I hire someone to fix a sink, then that is an independent contractor because they are engaged in a different business.
It’s important for both employers and independent contractors to define their business very specifically because if any way they can be construed as similar, they might be considered an employee. A classic example is Uber: Uber is part of the gig economy, and in the courts they have said that their drivers are in the transportation business, but they themselves are a tech company. Some courts have accepted this and some have rejected it.
C: The employee or contractor must be engaged in independently established trade, occupation, or business. So if you’re a plumber fixing people’s sinks all over the county, then you’re an independent business, but if you are a plumber working for one single person or entity, and that’s all you do is go around fixing the sinks for that single entity, then you’re going to be an employee.
If it is determined through this test that someone who was hired as an independent contractor should have been an employee, who is responsible for paying the taxes? The employer. The employer will be subjected to a number of problems, including paying whatever penalties are stated in the labor code and the attorney’s fees of the plaintiff for suing you. So you get cake in your face and a kick in the behind, too.
Some companies are trying to get around the consequences of AB5 by simply having what would otherwise be an employee incorporate or obtain a business license. While that may meet some of the requirements, it won’t help you pass the ABC test. If you’re still engaged in the same business of the employer, and/or under the direction of that employer, then you will fail the test. You need to meet all of the ABC test, not just one or two.
For small to medium-sized businesses with a number of employees, this can be a killer if you are not classifying your employees correctly under the law, and the penalties and fees could potentially put you out of business.
Yet AB5 doesn’t apply to everyone and includes a number of exemptions for specific types of work, and it’s very important to review the industries that are exempt. For example, graphic designers are exempt under AB5. A few others are: doctors, lawyers, architects, engineers, real estate agents, fine artists, estheticians, barbers, tutors, etc. Also, if you get an independent license from the state, you are more likely to be exempt.
Some further tips:
1. Keep up with what the people who work for you are doing, how they are classified, and how the law is evolving.
2. Very carefully define what their business is versus what independent contractors do.
3. Be vigilant. Don’t just do your regulations day 1 and then forget about it, as the law is constantly evolving and these rules are extremely vague.
4. Take precautions. For employers that include class action waivers, etc.
Employers can be annoyed and scared about these new laws for good reason, but it’s also important to recognize that they can also help us do the right thing.
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