October 25, 2019
What AB 5 Means for Worker Classification
Posted by Jenn McCabe
A new California law just reignited the freelancer (independent contractor) versus employee discussion. Other states are expected to follow suit. So if you thought you had your worker classification thing figured out, you might need to think again.
California’s governor signed Assembly Bill 5 (AB 5) on Sept. 10, 2019. It addresses worker classifications and brings the discussion into the legislative forum, along with new complexities, industry exemptions and deadline extensions. (For more details on AB 5, see our FAQ sheet.)
Technically, the new law goes into effect on January 1, 2020. However, this is just the most recent, and most formal, action in a 10-year-long policy shift. It follows the California Supreme Court’s April 2018 Dynamex ruling, which made their definition of “employment” crystal clear. (See Dynamex Operations West, Inc. v. Superior Court, __ Cal.5th __, 2018 WL 1999120). That ruling established a three-part “ABC test” to determine worker classification in the state.
The rules are clearer now than before (yay). There is virtually no grey area or weighting of factors regarding “degree of control” exercised over the worker (bummer). Note that the federal standards are still a bit hazy and allow for more interpretation of control.
But beware: Regulatory agencies have been applying the concept of the ABC test to determine worker classification for a while now, and in some cases, auditors apply rigorous testing to up to three years of previous information. We are finding it’s less expensive to comply than to look for wiggle room. Audits cost money and time even if you can avoid most penalties and interest.
Keep in mind that these rulings are ultimately meant to protect workers. Even if you consider yourself a “good” employer, the rules apply because the state wants you to employ more workers unless there is ample proof they take care of themselves. It’s not just about tax revenues, though it surely helps them control the process when taxes are withheld and paid by an employer.
Applying the ABC Test
The ABC test is complicated, so we created a decision tree to help employers classify a worker quickly. Basically, everyone should be considered an employee unless they specifically fit into an exempt category or unless the employer can rebut this premise using all three critical factors below:
- If this worker owns and independently operate a trade of their own, they should easily prove it by providing a federal ID number, a business license, professional insurance, or some sort of professional license number. They should look and act like a business owner. This is factor C, but we put it first in our decision tree.
- The work being performed should be outside the normal course of business and service provided by the hiring entity. (See the exemption discussion below.) This is Factor B, which we also put second.
- If the worker is directed, doesn’t have a direct financial relationship with the client, is told where, when or how to do the work, put them on payroll. This is a degree of control judgement call. We put this third on the decision tree. If you get this far, it’s the trickiest and most likely to result in a discussion and weighted factors.
There are exemptions to the ABC test. We are watching the politics here carefully because we expect this to continue to evolve. There is a pattern (if you ignore the newspaper delivery exemption). Professional organizations who license and regulate their subscriber base have been successful in getting exemptions for their constituency.
Veterinarians, CPAs, doctors and lawyers are examples of exempt categories. All those folks have licenses and carry professional insurance. But this is not an automatic pass — they still need to behave like independent business owners and provide evidence that they do so.
We’ll keep you posted as this continues to play out.
Not confident that you’ve got your worker classification process nailed? Feel free to call our HR experts for help, even if you are not a California employer. We can evaluate your risk, suggest remedies, and implement workflow changes to reroute payments to payroll before they are incorrectly processed as a vendor payment.
Jenn has more than 25 years of outsourced accounting and finance experience, with a particular expertise in startups and the advertising and creative production industries. She is passionate about seeing companies utilize the latest accounting technology to maximize their efficiency, productivity, and ultimately, success.
Before joining Armanino, Jenn founded and led Team Jenn Corp., a firm dedicated to the strategic financial management of startups and small businesses, offering a comprehensive back office solution with accounting, finance and HR solutions. Previous roles include stints at advertising giant Ogilvy and Mather, and in the cash management industry.
Jenn has a bachelor’s degree in economics from Pepperdine University and is a member of several professional associations including the National Society of Accountants, ProVisors and the Women’s Business Enterprise Network.
Co Authors :
Shannon Oswald works in the HR Solutions Group at Armanino LLP. She holds a Master’s Degree in Human Resources Management and a Senior HR Professional (SPHR) certification. She has a broad background in HR consulting, having worked in many different industries, including tech companies and start-ups. She spends her free time thinking about work and writing posts for Armanino newsletters.