California EDD Employment Tax

California’s AB5 legislation has been in effect for 5 years. This legislation changed the legal standard the Employment Development Department (EDD) used in California employment tax audits for determining whether a worker was an employee or independent contractor for most workers. At the time AB5 passed, its critics and proponents claimed it would be a huge game changer for employers in California. As someone who works with the EDD regularly, AB5 may not have caused anywhere near a seismic shift. So, after 5 years of AB5 – what did it really do to California EDD employment tax?

Under the AB5 rules, a worker’s employment status is generally determined by a three-part test (called the ABC test or Dynamex Test). Under the three-part test, a worker’s relationship with a hiring entity can only be considered that of an independent contractor if the relationship meets all three of the following requirements:

A. The worker is free from the control and direction of the hiring entity;
B. The worker performs work that is outside the usual course of the hiring entity’s business; and,
C. The worker is customarily engaged in an independently established trade, occupation, or business.

The ABC test first came to California when the California Supreme Court announced it would apply the ABC test in the 2018 Dynamex wage order case. At the time of the Dynamex ruling, there was some doubt as to whether the EDD would apply and adopt the Dynamex ruling in employment tax audits. The California legislature clarified the law by passing AB5 which codified Dynamex and extended it to most employer-employee relationships in California.

AB5’s effects on many businesses were lessened by its exemptions. AB5 also has carveouts which allow businesses such as construction contractors and law firms to continue operating as they always have. While AB5 posed an existential threat to app-based businesses such as Uber and Grubhub, Proposition 22 provided these app-based businesses an exemption from the AB5 regime.

On its face, the AB5 legislation seems to make it more difficult for California businesses to treat workers as independent contractor. The standard of the ABC test appears to be more rigid than the prior multi-factor Borello Test. Surely there are businesses in California with independent contractor relationships that met the Borello test that had to revamp their independent contractor relationships or put workers on payroll after AB5 went into effect. However, AB5 may not have had a significant effect at EDD audits because many employers would have failed the Borello test anyway.

Written by Joseph Cole, Esq., LL.M.