California passed a law (AB5), effective January 1, 2020, that dramatically changes the rules employers must use to determine whether workers are employees or independent contractors ("ICs") in the state. The distinction is important because independent contractors are not entitled to most of the protections and benefits that employees get. This includes a minimum wage, overtime pay, unemployment insurance, workers’ compensation insurance, and paid family leave.
As a result of AB5, many California workers who have previously been classified as ICs should be reclassified as employees and will be entitled to these benefits and protections. The law applies to all workers in California—regardless of where the employer is based—but does not apply to workers outside of California even if the employer is in California.
The law was aimed primarily at workers who obtain temporary (“gig”) work through online hiring platforms such as Uber, Lyft, Postmates, and many others. However, the law applies to all California workers, except for those in several job categories who were specifically exempted from its reach. For a detailed discussion of the many execeptions to the law, see Nolo’s article, Exempt Job Categories Under California's New Worker Classification Law (AB5).
Under the law, a “pro-worker” ABC test must be used to determine if most California workers are employees or independent contractors for most California employment law purposes. Under this test, all workers are presumed to be employees. A worker qualifies as an independent contractor only if the person satisfies a new “ABC test.” Under this test, a worker is an IC only if he or she:
(A) 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, and
(B) performs work that is outside the usual course of the hiring entity’s business, and
(C) is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
All three prongs of the ABC test must be satisfied for workers to be independent contractors. In other words, to be an IC a worker must: be free from control + work outside the hiring firm’s usual business + have an independent business.
It’s difficult for most workers to qualify as independent contractors under the ABC test. Let's say you're running a bona fide independent business. A client hires you and you do your work free from the hiring firm's control. Under prior law, this would be enough to make you an IC. But it's not enough to pass the ABC test. To pass this test, your work must also be outside the hiring firm's normal business.
There’s nothing new about the ABC test. It’s been used by about 20 states for various purposes for many years. Let’s look closer at each prong.
The first part of the ABC test, Prong A, requires that the hiring firm not have the right to exercise control or direction over the worker’s services. The hiring firm's control must be limited to accepting or rejecting the results the worker achieves, not how he or she achieves them. This is simply a restatement of the common law right-of-control test—the test used to determine worker status for IRS and many other purposes.
In California, the following different factors are looked at to determine if a hiring firm has the right to control a worker. Namely, whether the worker:
No one factor is determinative, and not all need be satisfied for a worker to be an IC. If the worker involved is under the hiring firm's control, there is no need to go on two the other two prongs of the test. The worker must be classified as an employee.
Prong B is satisfied only if the worker’s services are outside the hiring firm's usual course of business operations. In other words, ICs should not be doing the same work the hiring firm's employees ordinarily do. This prong would be satisfied, for example, if a bakery hires an outside plumber to repair a leak in a bathroom on its premises. The plumber’s services are not part of the bakery’s usual course of business. On the other hand, if a bakery hires a cake decorator to work on a regular basis on its custom-designed cakes, that worker is part of the bakery’s usual business.
Prong B was not formerly used in California. Quite simply, a worker can’t satisfy Prong B if he or she performs services related to the hiring firm's core business. Most gig economy companies like Uber and Lyft will likely not be able to satisfy Prong B. Arguably, the drivers Uber/Lyft hires and classifies as ICs are performing services in the usual court of Uber/Lyft’s business—driving passengers for hire. However, Uber and Lyft have claimed that their drivers are not part of their core business, which is serving as a technology platform for several different types of digital marketplaces. This is an issue the courts will have to resolve.
The final part of the ABC test requires that the worker be engaged in an independently established trade, occupation, or business. This means that the worker’s business activity must exist independently of, and apart from, the service relationship with the hiring firm. It must be a stable, lasting enterprise that will survive termination of the relationship with the hiring firm.
There are many ways to show that a worker is in an independent business or trade. Factors that are considered include whether a worker:
Again, no one factor is determinative and not all are required. It all depends on the facts and circumstances.
AB5 requires the ABC test be used to classify workers for purposes of the California employment laws listed below. If a California worker must be classified as an employee under the ABC test, the worker's employer must provide the worker with the benefits and protections mandated by these laws.
Workers who must be classified as employees under the ABC test are covered by wage orders issued by the California Department of Industrial Relations, Industrial Welfare Commission. The most common wage order involves the California minimum wage. As of 2019, the minimum hourly wage in California for businesses with more than 25 employees is $12.00. For businesses with 25 or fewer employees it is $11.00 per hour. Further rate increases are scheduled annually through 2022. Some California cities have higher minimum wages.
Other wage orders require employers to:
As employees, the workers must be provided with California unemployment insurance. Their employers must register with the California Employment Development Department and pay unemployment insurance premiums. For more information, see Nolo's article Employer's Guide to Unemployment Insurance Tax in California.
California law requires all employers with at least one employee to have workers’ compensation insurance. Such insurance can be obtained from private carriers or the State Compensation Insurance Fund. For more information, see Nolo's article Workers' Compensation in California: An Overview for Employers.
California Paid Family Leave provides up to six weeks of partial pay to employees who take time off from work to care for a seriously ill family member or to bond with a new child entering the family through birth, adoption, or foster care placement. For more information, see Nolo's article California Paid Family Leave.
California requires all employees to pay into its short-term disability insurance (SDI) program through payroll deductions. Employers make no contributions, but must make payroll deductions and send the money to California’s Employment Development Department (EDD). For more information, see Nolo's article California Short-Term Disability Benefits.
California's AB5 law only requires that employers use the ABC test for purposes of the state employment laws listed above. The law does not require hiring firms to use the ABC test for other purposes. For example, it need not be used when determining whether a worker is an employee or IC for federal tax purposes. Instead, the more flexible right of control test is used by the IRS. Under this test, workers are employees if the people for whom they work have the right to direct and control the way they do their jobs—both the final results and the details of when, where, and how the work is performed.
The right of control test is also used to determine whether a worker is an employee or IC for purposes of the Affordable Care Act. The ACA requires employers with more than 50 full-time employees to provide them with health insurance.
It’s possible for a worker to qualify as an IC for IRS and other purposes under the less strict right of control test and be an employee under the ABC test for California employment law purposes. In this situation, the hiring firm wouldn’t withhold or pay federal payroll taxes because it classifies the worker as an IC. But it would follow California minimum wage and overtime pay laws because it classifies the worker as an employee for wage and hour purposes. Obviously, this could be complicated and pose practical problems.
However, some hiring firms may elect to exert more control over workers who must be classified as employees under the ABC test. This could result in them having to be classified as employees under the right of control test.
AB5 will not magically convert all California ICs into employees on January 1, 2020. It is up to each business that hires workers in California to determine whether (1) workers it has already classified as ICs should be reclassified as employees, and (2) whether new workers should be employees or ICs. Uber and Lyft did not reclassify their drivers as ICs after the law went into effect.
What if a hiring firm fails to follow AB5 and misclassifies a worker as an IC? A hiring firm's decision to classify as worker as an IC is subject to administrative review by the California Labor Commissioner, the Employment Development Department, the Franchise Tax Board, and other agencies, usually on a case-by-case basis. In addition, lawsuits by Uber, truck drivers and others have been filed challenging the new law. AB5 empowers the California attorney general, city attorneys in large cities, and local prosecutors to sue hiring firms for misclassifying workers. Individual workers can bring their own lawsuits, including class actions on behalf of large numbers of similarly situated workers.
Hiring firms that are found to have misclassified employees as ICs can be required to pay fines, penalties, and back pay and benefits. In addition, California law imposes a civil penalty of up to $25,000 per violation on an employer that willfully misclassifies individuals as independent contractors.
The litigation engendered by AB5 will doubtless go on for years. The courts may delay full implementation of AB5 while the court process plays out. In the meantime, several industries, such as trucking, that were not granted exemptions from the ABC test in the final version of AB5 are attempting to convince the California Legislature to revise the law to exempt them from the test.