AB 5 & Dynamex (Independent Contractors verses Employees)

The new AB5 law which took effect on January 1^st, 2020 has definitely changed the way businesses will classify Contractors and Employees forever.  Within that law are the new ABC testing requirements and is definitely going to challenge many businesses in California.  As a 20-year business consultant, I found it amazing that many business owners would classify their employees as 1099’s simply because their newest employee (or 1099 person) decided that was best for them.  No determination was done to confirm whether that was legal, it was simply, it would be easier for both parties.  I get it, why not make it as easy as possible for both parties right?  

When Senate Bill 459 was signed into law by Governor Brown in September of 2011 businesses started to take notice.  The fines for misclassifying employees went up and liability for employers also went up.  But people were still using the old Borello test and businesses weren’t challenged much unless their 1099 contractor couldn’t pay their taxes or the EDD decided to do an audit.  But with the recent Dynamex ruling via the Supreme Court of California, things have really changed.  The newest AB5 provides some significant clarification that needs to be applied in most businesses in California.  There are some exemptions we will review in a bit. 

So what’s changed?  AB5 law and the ABC test, and these are the new parameters…A hiring entity classifying an individual as an independent contractor now bears the burden of establishing that such a classification is proper under the “ABC test.” To do so, the entity must prove each of the following three factors:

1. That 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;
2. That the worker performs work that is outside the usual course of the hiring entity’s business; and 
3. That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.  

Even if the Contractor does meet these requirements, the business still has to make sure their Contractor is acting as a true business entity; they have an established business with a Fed Id #, they have a business license, they advertise, promote their business, have additional clients.  The additional client part is important, because on the Department of Industrial Relations website, it states that if an individual relies on a single employer, then the Part C test above is not met. 

But AB5 does have exemptions, because those industries had lobbyist who were strong and they were able to get their industries an exemption for AB5, but even these companies still have to follow the old Borello test. But below is an example of some of the AB5 exempt listed industries…

• Certain licensed insurance agents and brokers
• Certain licensed physicians, surgeons, dentists, podiatrists, psychologists, or veterinarians
• Certain licensed attorneys, architects, engineers, private investigators and accountants
• Certain registered securities broker-dealers or investment advisers or their agents and representatives
• Certain direct salespersons 
• Certain licensed commercial fishermen (only through December 31, 2022 unless extended by the Legislature)
• Certain newspaper distributors or carriers (only through December 31, 2020 unless extended by the Legislature) 
• Certain professional services contracts for marketing; human resources administration; travel agents; graphic design; grant writers; fine artists; enrolled agents licensed to practice before the IRS; payment processing agents; still photographers/ photojournalists; freelance writers, editors, or newspaper cartoonists; licensed barbers, cosmetologists, electrologists, estheticians, or manicurists (manicurists only through December 31, 2021). Borello applies to determine whether the individual is an employee of the hiring entity if initial requirements are met.  

This list is not all inclusive but you can find the full list on the California Department of Industrial Relations website. 

There you go, it’s as clear as day right?  Black and white, just like California intended it to be.  Well, not exactly.  The safest route will always be to classify the individual as a W-2 employee, put them on payroll, and pay those taxes.  I have met with so many businesses who had 1099’s who ultimately end up truly being W-2 employees.  How did they find out they were misclassified?  When that 1099 couldn’t pay their year end taxes and the IRS auditor said, “do you think you should have been an employee?” and the 1099 contractor says “YES.”  Guess who’s knocking at your door then?  The IRS and the other government agencies who want their money because someone is paying those taxes.

Want some help with the never-ending California labor law mandates?  Harbor HR can help. 

Written by Glen Drouin, founder and owner of Harbor HR, LLC.  Glen has 13 years experience working with his Father’s business and 20 years experience as an HR and business consultant. You can reach Glen at 916-293-2116 or e-mail at glen@harborhr.com .