Assembly Bill 5 (AB-5)
Assembly Bill 5 (AB-5) is the new standard by which employers must classify employees. Business owners must now classify workers by using AB-5’s ABC Test.
What is Assembly Bill 5 (AB-5)?
CA Assembly Bill (AB-5), inspired by the Dynamex Case April 2018, was signed into law by Governor Gavin Newsom in September of 2019. It went into effect on January 1, 2020. This is not just another bill. The new AB-5 law directly affects the way Small Business Owners who hire Independent Contractors will operate in California. The law impacts all Small Business Owners.
In a nutshell, this new law redefines the way you as a business owner must classify your workers. The California Employment Development Department (EDD) placed the burden of proof on business to show that workers are correctly classified as 1099 contractors and that they should not be reclassified as employees under the stricter criteria set out in the new law. Business owners must now classify workers by using AB-5’s ABC Test.
What is the ABC Test?
Under the ABC test, a worker is considered an employee and not an independent contractor, unless the hiring entity satisfies all three of the following conditions:
- 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;
- The worker performs work that is outside the usual course of the hiring entity’s business; and
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
The new, stricter legal regulations push business owners to employ workers as W-2 employees if they do not meet ABC test criteria and pay for benefits and protections (unemployment, overtime, sick leave, and worker’s comp) that employees get under California Law.
There are, however, several exceptions for specific industries and job categories. For those industries, the worker classification guidelines under the 13 Factor Borello Test remain the standard by which CA EDD will determine worker classification.
What is the 13 Factor Borello Test?
Before AB-5 was signed into law, there were 13 criteria (the 13 Factor Borello Test) used to determine if a worker should be classified as a contractor or as an employee. The Borello test classified workers as either W-2 employees or 1099 independent contractors. This test is less straightforward than the updated AB-5 that includes clearer guidelines under its ABC test.
Even with the new AB-5 regulations, however, you can still reference the Borello test if there are exemptions, exclusions, or confusion in classifying independent contractors. Workers exempt from the ABC Test are not automatically considered independent contractors and must also meet the Borello factor’s requirements to be considered independent contractors.
EDD provides the full Borello Test worksheet with the following questions to help guide classification:
- Do you instruct or supervise the person while he or she is working?
- Can the worker quit or be discharged (fired) at any time?
- Is the work being performed part of your regular business?
- Does the worker have a separately established business?
- Is the worker free to make business decisions that affect his or her ability to profit from the work?
- Does the individual have a substantial investment in their job which would subject him or her to the financial risk of loss?
- Do you have employees who do the same type of work?
- Do you furnish the tools, equipment, or supplies used to perform the work?
- Is the work considered unskilled or semi-skilled labor?
- Do you provide training for the worker?
- Is the worker paid a fixed salary, an hourly wage, or based on a piece-rate basis?
- Did the worker previously perform the same or similar services for you as an employee?
- Does the worker believe that he or she is an employee?
Answering “yes” to questions 1-3 would provide a strong indication that the worker is an employee. Answering “no” to questions 4-6 would indicate that a worker is not in business for themselves and would likely classify as an employee. Questions 7-13 indicate important factors to be considered.
While answering “yes” to any one of them may indicate that a worker should be classified as an employee, no single factor is enough to determine so independently.
The full worksheet provided by EDD provides further clarification on certain factors and circumstances.
If completing the provided worksheet does not provide sufficient clarification for employers, EDD offers the ability to request a written ruling by completing a seven-page form called Determination of Employment Work Status. The form supports any business entity looking to determine if a worker is an employee or an independent contractor.
Why is Correct Classification Important?
EDD takes classification seriously and performs thorough audits because they directly impact payroll taxes—essentially the money the government receives. The agency doesn’t receive proper taxes owed from the business owner or the hired workers when they are misclassified.
These strict regulations are also in place to protect workers. Workers misclassified as 1099 independent contractors, when they are truly W-2 employees, do not receive the same type of benefits, such as employment benefits they are entitled to.
This strips employees of their benefits such as:
- Medical insurance
- Paid time off
- Retirement
- And more
What Happens If You Misclassify Workers?
Misclassifying an employee as a 1099 independent contractor can trigger an audit by California Employment Development Department (EDD). Companies who are audited and whose 1099 contractors are reclassified as employees will be assessed for their payroll taxes on the total payments to these misclassified workers, which includes taxes, penalties, and interest.
A few of the top EDD audit triggers are:
- Independent contractor filing for unemployment
- Employee complaint
- Late Filing of Taxes
- Randomized verification audit
If your business undergoes an EDD audit, and the agency finds you misclassified employees as workers, your business will be subject to fines, penalties, and possibly jail time.
What Happens If You Misclassify Workers?
Misclassifying an employee as a 1099 independent contractor can trigger an audit by California Employment Development Department (EDD). Companies who are audited and whose 1099 contractors are reclassified as employees will be assessed for their payroll taxes on the total payments to these misclassified workers, which includes taxes, penalties, and interest.
A few of the top EDD audit triggers are:
- Independent contractor filing for unemployment
- Employee complaint
- Late Filing of Taxes
- Randomized verification audit
If your business undergoes an EDD audit, and the agency finds you misclassified employees as workers, your business will be subject to fines, penalties, and possibly jail time.