Employee or Independent Contractor: A Year in Review of California’s AB 5

Nearly a year into work from home orders and COVID-19, we can reflect on the one-year anniversary of California’s worker classification law, Assembly Bill 5 (“AB 5”), which was signed into law in September 2019 and effective January 1, 2020. AB 5 codified the California Supreme Court decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) and expanded the scope of the “ABC Test” for worker classification in the state. Over the course of its first year, AB 5 has faced a number of hurdles, including legal challenges and ballot-based initiatives.

Understanding AB 5

In order to understand the implications of AB 5, it is imperative to understand the law prior to Dynamex and AB 5’s enactment. Prior to the Dynamex decision, worker classification in California was governed by the test pronounced in S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989), a common-law test adopted from a 1989 California Supreme Court decision. The Borello test requires a multi-factor analysis, in which no individual factor holds greater weight or is dispositive on its own.

The enactment of AB 5 generally jettisoned the multi-factor analysis and implemented a rebuttable presumption that workers are employees. In order for a contracting business to refute the presumption, they must satisfy all three requirements of the ABC Test.

1. The worker is free from the control and direction of the hiring entity related to the performance of the work under contract and in fact.
2. The worker performs work that is outside the usual course of the hiring entity’s business.
3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

AB 5’s Exceptions

As the adage goes, there is always an exception to the rule. For AB 5, those exceptions are fairly numerous and include:

• Certain licensed or credentialed occupations, such as certain medical providers, attorneys, architects, accountants, registered financial and investment advisors, and insurance agents and brokers;
• Professional service providers that meet additional requirements; and
• Certain bona fide business-to-business relationships.

If one of the above-enumerated exceptions applies, then the Borello test, and not the ABC Test, is used to determine whether the individual is an employee or an independent contractor.

Professional Service Providers

In order for a business to qualify for the professional services provider exception to AB 5, the worker must provide “professional services.” For this purpose, professional services are defined to include marketing, human resources administration, travel agents, payment processing agents, graphic design, grant writers, certain freelance writers and photographers, hair stylists and barbers, and certain builders and construction contractors.

Additionally, to qualify for the exception, the professional service provider must satisfy five additional requirements, if applicable:

1. The individual maintains a business location (which may be a residence) that is separate from the hiring entity;
2. If the work is performed more than six months after the effective date of AB 5, the individual has a business license in addition to any required professional licenses or permits;
3. The individual has the ability to set or negotiate their own rates;
4. Outside of the project completion date and reasonable business hours, the individual can set his/her own schedule; and
5. The individual is customarily engaged in the same type of work performed under contract with another hiring entity or holds themselves out to the general public.

Business-To-Business Relationships

The business-to-business relationship exception is not confined to any specific occupation, industry, or service. Rather, in order to qualify for the exception, the contracted workers must have formed, and been engaged by the hiring entity, through their own business, and the relationship must satisfy the following additional criteria:

1. The service provider is free from the hiring firm’s direction and controls while performing the work (per the contract and true in fact);
2. The service provider provides services directly to the contracting business rather than customers of the contracting business;
3. The service provider has a written contract;
4. The service provider has all required business licenses or business tax registrations;
5. The service provider maintains a business location separate from the business or work location of the hiring firm;
6. The service provider is customarily engaged in an independently established business of the same nature as the work performed;
7. The service provider actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring firm;
8. The service provider advertises and holds itself out to the public to provide the same or similar services;
9. The service provider provides its own tools, vehicles, and equipment to perform the services;
10. The service provider can negotiate its own rates; and
11. The service provider can set its own hours, the location of the work, and the work is consistent with the service provider’s other work.

Legal Challenges and Ballot Based Initiatives

Even before the effective date of the law (January 1, 2020), legal challenges to AB 5 were underway. While most of these legal challenges have not been successful, the California Trucking Association did experience some success, obtaining a preliminary injunction in December 2019 due to the trucking association being subject to federal regulation and the Department of Transportation. This specific issue is currently being reviewed by the 9th U.S. Circuit Court of Appeals. California, not content to wait, obtained a favorable decision in the California Court of Appeals in November 2020 that motor carriers are not exempt from AB 5. However, the state court’s opinion will not dictate the decision of the federal appellate court.
Additionally, the gig economy, while largely unsuccessful in its legal challenges, obtained relief with its ballot-based initiative, Proposition 22, the Protect App-Based Drivers and Services Act. As discussed previously, Proposition 22 provides limited relief from AB 5’s ABC Test for the classification of certain workers performing rideshare and delivery services. However, Proposition 22 is a narrow carve-out and other initiatives have not been successfully placed on the ballot thus far.

A New Trend?

As we enter 2021, there are a few things we know for sure. AB 5, while controversial in some instances, is here to stay. It remains to be seen how California enforces AB 5. However, the ABC test may not be limited to California, as other states have either started the legislative process or stated that they intend to follow California’s lead and adopt their own, more restrictive worker classification standards. For example, the New Jersey legislature introduced proposed legislation and New York’s Governor Cuomo proposed creating a task force to evaluate worker classification and regulate the gig economy.

As states continue to explore their own criteria for worker classification, it will become increasingly more complicated for hiring entities to determine whether a worker is an independent contractor or employee for federal and state tax purposes. As states refine their worker classification rules or adopt new and more stringent rules like the ABC test, hiring entities may find themselves in a situation where similarly situated workers may have different worker classifications at the federal and state levels.

While this article has focused on the US tax rules regarding worker classification in California, worker classification has become a concern outside the US as well. The United Kingdom’s Supreme Court issued a ruling on February 19, 2021, that Uber drivers should be classified as employees, not independent contractors. The UK court looked to the control exerted by Uber over the driver’s activities and fare schedule in making their determination. This case may now prompt a review of other companies providing app-based services in the UK.

A&M Tax Says

With the ever-changing workforce and legal landscape, it is more important now than ever for businesses to evaluate their workforce and the potential rule differences that could result in a worker being an employee in one state but a contractor in another. One question that is sure to remain is whether a worker is an independent contractor or an employee. As state laws evolve, this question is likely to become more complex in our digital environment that regularly crosses state lines. We recommend that businesses evaluate their current worker classification procedures, understand state rules as they onboard new contractors and evaluate potential acquisitions with significant independent contractors. Additionally, where state and federal worker classification rules differ, we recommend that businesses follow the proper wage reporting requirements to reflect the disparate treatment.  A&M has broad experience in identifying and planning for worker classification issues and would be happy to discuss your particular situation.

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