What California AB5 Means For Companies and Independent Contractors

Gig work is everywhere. From DoorDash, to Uber, to Instacart, the gig economy is a major part of the Americanand world’s—economy. We’ve grown accustomed to swiping on our phones for everything. We love the ease of use, and more companies are popping up daily. The model isn’t going anywhere.

But, the problem with the gig economy is that it’s a new frontier; nothing like it existed before. Like for most things driven by technology, the rules are being made by companies as they operate, and governing bodiesboth federal and state-wide—are playing catch-up after the fact. (The collection of antitrust hearings on Capitol Hill for many of tech’s big players and the troubles of companies like Uber and Lyft in California are just the start.)

Understanding California’s AB5 Labor Law

When California passed the AB5 bill, the country’s most populous state took the gig economy and independent contracting into its own hands. The bill, officially known as “California Assembly Bill 5” or the “gig worker” bill was signed into law by Governor Gavin Newsom in September 2019 and went into effect January 1, 2020. The big noise around the bill, which made headlines nationally, requires companies hiring independent contractors (ICs) to reclassify them as employees. AB5 is an expansion of the 2018 California Supreme Court ruling in Dynamex Operations West, Inc. vs. Superior Court of Los Angeles. 

Two of the most prominent opponents of the bill at the time were Uber and Lyft, both citing that reclassification would disrupt their business models. Nevertheless, the bill was passed, and now all companies using gig workers and ICs for large amounts of work have to act within the law’s guidelines. (A lawsuit on behalf of the rideshare giants has been filed and is currently working its way through the courts, so the situation is a work in progress, with multiple lawsuits on the books. It should still be taken seriously.)

How big is the AB5 bill when put into perspective? 400,000 Californians work within the gig economy, with nearly 1.5 million freelance workers plying their various trades. The AB5 legislation impacts companies in multiple industries. 

AB5 states that independent contractors working a certain amount of hours for a company are entitled to the same protections and benefits as other W-2 employees. This also means employers must pay half of each employees’ Social Security tax.

What Constitutes an Independent Contractor in California?

California Labor Code section 3353 defines an independent contractor as a “person who renders service for a specified recompense for a specified result, under the control of his principal as to the result of his work only and not as to the means by which such result is accomplished.” 

An employee and an independent contractor have some clear distinctions between them: 

  • W-2 Employees work for an employer that controls the work – what will be done and how it will be done. The employer also carries workers benefits, vacation time, and withholding for annual taxes.
  • Independent contractors are professionals in a trade or business offering services to the general public. Independent contractors are self-employed, and their earnings are subject to self-employment taxes

Independent contractor isn’t a one-size-fits-all term. There are various jobs and skills for these specific kinds of workers. Some examples include:

  • Advisors (legal, financial, personal)
  • Tax professionals 
  • Doctors 
  • Accountants 
  • Trades workers (Electricians, Plumbers, Carpenters, etc.)
  • Florists
  • Mechanics 
  • Warehouse workers   

How Does AB5 Affect Independent Contractors?

The entirety of the bill has multiple layers, which is one reason this law is challenging for many. 

Costco is an example. While the retail giant is known for selling bulk goods like food and toilet paper by the football field, Costco also offers services. If you buy a new television or an oven, Costco contracts out installation workers paid by the job, not by the hour. This immediately challenges AB5 because these installation workers are not full-time workers; they’re a specialized option which isn’t used all of the time, but it’s there. 

Costco isn’t an outlier, either. There are many companies within the supply chain with workers like truckers and warehouse workers, and cleaning crews; these companies have different structures for how they hire and work with independent contractors. While some of these companies may only need workers for a few additional hours at a time, part of the problem is that some companies saw having a business model that only relied on ICs as viable. This opened the lane to predatory behavior that shorted people who were working full-time hours; these workers were working the hours, but not receiving any of the benefits like health care, paid vacation, sick time, retirement plans, and unemployment insurance.

AB5 reshapes the future of independent workforces in California. The ABC Test assumes all workers are employees. If a company wants to dispute this, it’s 100% their job to prove it with documentation that explicitly shows the worker hits all three test criteria. Matching one or two doesn’t count.=

Pre-AB5, California used the multi-factor Borello test, making it easier to classify workers as independent contractors. Still, it’ll be on the company to show that the points of the test are adequately hit.

Enforcing AB5 will be interesting because of the complexities of what law dictates and how a court sees the law put into action. State-wide internal agencies will look at worker classification, which could trigger more expansive audits for companies with many contractors vs. actual full-time workers. If there’s improper classification, this could mean serious legal problems and fines for companies not playing within the lines of AB5. There will likely be many court cases, but for companies without the financial means of a massive company like Uber, it’s best to play by the rules. 

Another thing businesses need to keep in mind is ineligible workers. Federal law states that every worker needs to fill out an I-9 form, which requires employers to verify that every employee is eligible to work in the United States. Before the AB5 bill was passed, the way an IC was labeled was spotty at best. (Prior to 2019, Uber’s and Lyft’s background checks were questionable.)

Many businesses staff up to meet demand, so depending on the business, some found it easier to hire ICs on a 1099 basis. But, on the gig worker side, AB5 can make it more difficult for workers to find flexible employment because businesses don’t want to be liable for misclassifying workers. The benefits of a W-2 classification only accrue to workers who can find W-2 employment. 

An intermediary (like Adia) can offer businesses in need of help a vetted, verified worker pool while allowing the workers themselves to keep the flexibility they need.  We’re not supplying W-2 employees, but are the employer of record for anyone on the job while the client shows our workforce what needs to be done.  This scenario is the best of both worlds. 

Why Was Assembly Bill 5 Passed?

The Dynamax court case was a big deal for California. Essentially, the parameters of what differentiated a gig worker, independent contractor, and an employee were constantly changing. Californiaone of the world’s largest economies partially driven by the gig economy—had to do something. The California Supreme Court ultimately rejected the Borello test, which was the standard in determining how workers were classified as W-2 employees or independent contractors. Under the new AB5 law, the standard presumes all workers are taxable employees, and it’s on the company to prove otherwise, hence the three-pronged ABC test inherent to the AB5 law. 

What kicked this whole thing off? It was a long fight between California and Dynamax, a nationwide same-day courier and delivery service that offers on-demand, same-day pickup. Way back in 2004, Dynamax classified all drivers as employees and then changed all drivers to independent contractors to save on taxes and benefits, and California noticed. 

One of Dynamax’s workers, Charles Lee, had an independent contractor agreement with Dynamex to drive for them. After leaving the company, Lee filed a lawsuit stating that there was a misclassification of what he was entitled to as a worker and a violation of the provisions of IWC wage order No. 9, the applicable state wage order governing the transportation industry.  Given the rise in gig economy opportunities (especially for drivers), it was a move to curb predatory behavior.  Because it was proven that Lee was misclassified, it opened the door to thinking about companies across the board and how they’re skirting not only labor laws, but also cutting corners on taxes, as well. This long court battle made the Supreme Court of California take a long, hard look at how workers were classified.

What is an ABC Test?

The California Supreme Court ruled that companies have to use a three-pronged test (known as the ABC test) to determine a worker’s classification. The independent contractor test has to prove three things: 

A. The worker performs services without the control or direction of the company
This means the worker must have complete freedom in how, when, and where they do the work. The company can’t control them. Just because there’s an agreement saying they’re free from control, if it’s not explicitly proven, this prong isn’t met.

Can you answer these four questions:

  • How much control do you have over how the employee does the work?
  • When the employee does the work?
  • Where the employee does the work?
  • Are you treating the worker like an employee or an outside business? 

These three criteria have to be met to pass the first prong.

B. The worker performs tasks outside of the company’s business activities

This is a big hurdle. Essentially, if you’re a social media manager, but hire someone to freelance specifically for a project considered within the “ordinary course of business,” it deems them ineligible to be an independent contractor. Another example would be a teacher with a side business of tutoring, hiring a freelancer specializing in email marketing. The email marketer, unless very clearly documented, can be viewed as an employee, not as a specialized contributor. Freelancers do have special allowances, but there needs to be explicit documentation to prove it in case of an audit. 

This determines actual business need. The principle issue here is making sure the employees that are integral to the model are recognized as such and not taken advantage of. This provision takes on rideshare and food delivery companies head-on because there is no business without the drivers.

C. The worker is engaged in an independent but established trade, occupation, or business of the same nature as the work performed

The person running their business typically has an entity and/or FEIN (instead of working under their SSN) and performs the same work for clients. An intermediary is working with an agency or platform to skip the hassle of classification. 

Who is Exempt From California AB5?

In the past, the older Borello test allowed for more nuances to be taken into account; AB5 is much more rigid. Thanks to a lot of lobbying when the bill was drafted, specific (mostly white-collar) industries have different allowances when planning for how their workers fit within the parameters of California AB5. All other sectors not cited have to do their homework to see if they fall within a possible gray area when looking for California AB5 exemptions.

KEEP IN MIND: Gig workers universally are not on the exemptions list. To clarify, anyone NOT on this list is subject to AB5’s ACB test. Anyone who falls within these specific categories will be given the standard Borello test. 

Around 50 professions or businesses are exempt from AB5, which include: 

  • Doctors
  • Dentists
  • Insurance agents
  • Lawyers
  • Accountants
  • Real estate agents 
  • Hair Stylists 
  • Architects
  • Engineers
  • Commercial fisherman (only till 2023)
  • Direct Sales/Network Marketing
  • Professional Services: Marketing, HR Administrator, Travel Agents, Graphic Designers, Grant Writers, Fine Artist
  • Writers/Photographers (no more than 35 submissions annually)
  • Estheticians, Manicurists

How Can a Business Stay Alive with AB5?

It’s essential to plan, not panic. AB5 will impact business, but how the law is interpreted is a work in progress. If there’s a fear of non-compliance, there are steps a company can take. 

Get lawyered up

Work with an attorney that knows independent contractor and employment law. These specialists understand the nuances and possibilities of potential changes and how to structure your independent contractor relationships. A good lawyer will help guide an HR team plan how to hire for the long term and for spikes in business while remaining compliant

Assess risk 

Conduct an audit of your independent contractor management processes to help understand what is and isn’t compliant, including:

  • Engagement guidelines
  • Contractual terms
  • IC incorporation requirements
  • Rate negotiations
  • Documentation processes
  • Work structure and level of control
  • Staff and IC interactions

Establish separation 

Establish vividly that this is a strict business relationship to stay compliant. AB5 specifically exempts business-to-business contractors from the ABC Test as long as they meet a set of 11 criteria which demonstrate that the contractor operates as a business entity.

How Adia Can Keep Companies and Contractors AB5 Compliant

Since AB5 launched in California, Adia has worked with various companies of all sizes to make sure they’re compliant. Because we hire our workers as W-2 employees—with an I-9 on handusing Adia is a workaround for businesses because we’re the employer of record. They’re not your employees. They’re ours. And using Adia can be written off as a business expense because we’re a technology platform. We’re an on-demand staffing platform that has a pool of 10X that of traditional staffing. Everything is controlled via our app, accessed through your smartphone, laptop, or tablet – it’s simple, you can learn just how quick  Adia.works.

We help businesses who need an extra set of hands in their warehouse, hospitality, event staff, and more. A company in need can set the hourly wage and the hours needed, and we’ll get the jobs filled in real-time, and all within AB5 compliance. 

Using Adia enables you to pass the ABC test – or avoid it altogether – because using our W-2 employees enables you to structure your staffing the way you need it, when you need it.

There’s always the possibility of more bills like AB5 popping up across other states in the nation. Till then, we’ll have to wait and see. Either way, we’re here to help you staff your business

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