California makes big changes to worker classification

In what could spark a national trend, California Gov. Gavin Newsom has signed Assembly Bill 5, dramatically changing the rules for determining when workers are considered independent contractors rather than employees.  The new law provides that workers are presumed to be employees unless the hiring entity meets a three-factor test, commonly known as the ‘ABC test’.

A worker is an employee under that test unless:

A: The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact
B: The worker performs work that is outside the usual course of the hiring entity’s business; and
C: The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

The new law codifies the same three-part test adopted by a 2018 California Supreme Court decision (Dynamex Operations West Inc. v. Superior Court of Los Angeles). Because businesses will have to satisfy all three factors, it could be difficult to characterize most workers as independent contractors. The law will have significant tax and labor law implications for California businesses. Many businesses will face more tax withholding and reporting requirements including statutorily mandated benefits and compensation such as the state $15 minimum wage. Businesses will also have to comply with employment laws governing hiring, firing, leave and many other issues.

While the law was originally aimed at workers in the sharing economy many of whom are independent contractors, the law has wide applicability. Trucking companies and many hospitals are heavily dependent on independent contractors. But, the law has many categories of worker that are not subject to the new ‘ABC rules’. The following types of workers are exempt from the new law: medical doctors, lawyers, architects, engineers, accountants, investment advisors, stock broker, real estate agents, commercial fishermen (until 2023), builders and contractors, marking agents, travel agents, free-lance writers and photographer, some hair stylists and barbers, private school tutors, and tow truck drivers. It should be noted that those categories are not automatically classified as independent contractors. Rather, they must meet the original 11-part test set forth under the prior law.

Takeaways

The new law takes effect in January 2020. Businesses in California will need to insure that all independent contractors meet the new test or are exempt from the law (and meet the old test). But beyond the specifics of A.B. 5, businesses nationwide should be aware that similar laws will be proposed in other states. Laws creating a version of the ABC test have already been passed in Connecticut, Delaware, Illinois, Indiana, Massachusetts, Nebraska, Nevada, New Hampshire, New Jersey, Vermont, Washington and West Virginia. Those seeking to limit the use of independent contractors will attempt to convince more states to enact such laws.

Companies that misclassify workers face potential liabilities. Businesses with independent contractors should consult their tax and employment advisors with respect to compliance with A.B. 5 and similar developments occurring in other states.