California’s new AB 5 law, also known as the Dynamex bill, is changing the landscape of worker classification in the state. The legislation has left business owners, and the workers they use, scrambling to understand the facts and how it will apply to them. The new rules are complex and are not uniform across different industries. It is expected to shift many workers from independent contractor to employee status, requiring them to be reported on payroll, with all the requisite withholdings and reporting that would entail.
Under AB 5, workers will be presumed to be employees unless they satisfy a new three-factor test, known as the ABC test. All three of these factors must be met in order to treat the worker as an independent contractor.
- A: The worker is free from the control and direction of the hiring entity in connection with the performance of the work
- B: The worker performs work that is outside the usual course of the hiring entity’s business
- C: The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed
The game-changer in these factors is B, that the worker perform work that is “outside the usual course of the hiring entity’s business”. This would mean that a delivery company cannot hire contractors to be delivery drivers. But a business that is not in the business of delivery COULD hire contractors to be delivery drivers (example, a law firm could hire contractors to be delivery drivers because they are not in the business of delivery).
Though this ABC test makes it appear that most contractors will now be employees, the final legislation did provide some exceptions to the new rules. Pages and pages of exceptions, and some with their own rules.
The following workers are exempt from the new ABC test, and will continue to follow the traditional “Borello” test to determine worker classification:
- Licensed insurance agents;
- Licensed physicians, surgeons, dentists, podiatrists, psychologists, and veterinarians;
- Licensed lawyers, architects, engineers, private investigators, and accountants;
- Registered securities broker-dealers, investment advisers, or their registered agents and representatives;
- Direct sales salespersons;
- Commercial fishermen (exempt only until January 1, 2023);
- Real estate licensees and repossession agents
PROFESSIONAL SERVICES EXEMPTION
Some other workers will fall into the “Professional Services Exemption” category. These professional services must meet the traditional “Borello” test, plus satisfy the following factors:
- Maintain a business location separate from the hiring entity. This could include an office in the home. The worker can still choose to do work at the hiring business but must maintain that separate location.
- Obtain any required business or professional licenses or permits (including city business license)
- Ability to set or negotiate their own rate of pay for services performed
- Ability to set their own hours
- Be customarily engaged in the same type of work under contract with another hiring firm (meaning, working for more than one business), or hold themselves out to other potential customers as available to perform the same type of work
- Customarily and regularly exercise discretion and independent judgment in performing their services
The Professional Services Exemption applies to the following workers:
- Marketing services
- Travel agents
- Human resource administrators
- Graphic designers
- Grant writers
- Fine artists
- Enrolled agents
- Payment processing agents through independent sales organizations
- Freelance writers, editors, or newspaper cartoonists who provide content submission no more than 35 times per year
- Photographers or Photojournalists who license content submissions no more than 35 times per year (exception not applicable to individuals who work on motion pictures)
There are other industries that have their own rules and exemptions, too numerous for the scope of this article. Some of the other industries that have their own rules are salon workers, newspaper distributors, construction subcontractors, workers provided through referral agencies, and others. The list will likely continue to grow and become more complex.
DIFFERENT STANDARDS FOR FEDERAL
While California is applying this new ABC test and making worker classification much more stringent, the IRS is still using just the traditional Borello test to classify workers. The differing standards could mean that a worker would meet contractor status for federal, but not reach that level for California.
Does this mean that a business could treat the worker as a contractor for federal and an employee for California? Some businesses are looking at this as an option. If this happened, the employer would issue a 1099 for federal, and a W2 for California. This will undoubtedly muddy the waters and make the reporting even more difficult for both the employer and the worker.
PENALTIES FOR MISCLASSIFICATION
California law provides for a civil penalty for “willful misclassification” of employees as independent contractors. This penalty can range from $5,000 to $25,000 for each violation. They could also be held liable for fines, back taxes and benefits related to those workers.
Worker status has been a big issue for years and with the addition of the new California rules, the complexity continues to grow. We are certain to see clarification and corrections in the new law as it goes into effect. Be sure to seek professional guidance if you are unsure how these rules apply to you and your specific situation.