What California's Assembly Bill 5 Means for Employee Classification and Future Contractors

October 14, 2019 - minute read

In California, which workers should qualify for minimum wage protection, sick leave, and other benefits? Full time employees? Contract workers? Both? California's Senate just reopened the debate and took its first major step in establishing a definitive answer.

California’s Senate has passed Assembly Bill 5 (AB5)—a bill which would require employers leveraging the gig economy to treat millions of independent contractors as employees. AB5 would re-classify contractors in California as employees if they work within management or in the usual course of a company’s business. Workers would be considered employees instead of contractors if a company exerts control over how they perform their tasks or if their work directly influences regular business operations. But… why?

As an employer, you know that contractors are often significantly less expensive to work with. In fact, the National Employment Law Project estimates businesses save roughly Since contractors don’t qualify for the same protections under the Fair Labor Standards Act, the Americans with Disabilities Act, or the Civil Rights Act as regular employees- and are largely responsible for paying their entire portion of payroll taxes- this bill seeks to safeguard contractors against potential exploitation and safety risks.

So, even if your business operates outside of California, are you prepared to make the necessary changes should this law reach your state?

 “ABC Test”

If you’re unsure of how to prepare, you’ll first need to identify the new classifications within your workforce. The “ABC test” that was released with the ruling allows for the classification of independent contractors only if employers can verify that:

(A) that the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract and for the performance of such work

(B) that the worker performs work that is outside the usual course of the hiring entity’s business

(C) that 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.

Other Ways to Classify Correctly (Non-California States):

In addition to this test, there are multiple sets of government guidelines for distinguishing between independent contractors and employees- all of which can be used to assess and fine your business based on their own evaluations. For a full summary of each set of guidelines, check out our blog “Independent Contractors vs. Employees: Classification Mystifications.” Here are additional tests to consider in determining the status of your employees:

  • The FLSA Economic Reality Test: Used by the DOL, this seven-factor economic reality test defines employment relationships from contractual ones by comparing the permanency of the employment relationship, your investment into their use of facilities and equipment, and more.
  • The IRS Right-to-Control Test: The IRS uses this 20-factor right-to-control test, which evaluates employee status based on three primary categories- the company’s behavioral control over the worker; the company’s financial control over the worker; and the type of relationship between parties.
  • State Independent Contractor Tests: In addition, some states have their own independent contractor tests. Be sure to check up on your state’s unique requirements and legislation news.

Tips for Classification Compliance

With a growing number of states lining up to follow in California’s AB5 footsteps, it’s a good idea to prepare early for potential changes. Because there is no single, definitive set of factors for distinguishing between independent contractors and employees, you need to deliberate carefully throughout the hiring process. Some legal experts suggest starting with an internal audit of your current contractors and working with legal counsel to ensure success.

In addition, it is recommended that you create guidelines for engaging future independent contractors, including:

  • Requiring independent contractors to sign an agreement defining the scope of the work, the agreed-upon compensation arrangement and both parties’ tax obligations.
  • Asking independent contractors to complete IRS Form W-9.
  • Requiring independent contractors to submit invoices for their work and specifying that payments be made upon completion of specific tasks as opposed to on a set schedule.
  • Refraining from providing independent contractors with equipment/supplies and from reimbursing them for expenses (that should be built into contract).
  • Refraining from offering employee benefits, providing an employee handbook, or asking self-employed contractors to complete job applications.

Even if you aren’t facing AB5 requirements now, it’s likely you’ll be facing some form of it in the near future.

EPAY Systems

At EPAY, we are committed to helping employers control their labor costs and maintain compliance. Our powerful HCM software is packed with built-in safeguards to help you do just that. Looking for more gig economy insight? Check out our on-demand webinar “The Future Workforce: The Gig Economy and the Challenges of a Contingent Workforce”.

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Filed Under: Compliance Human Capital Management HR News Employee Benefits BSCs