Easier Access to Labor Complicates Workers’ EDD Classification – Contractor vs. Employee

You are an innovator. You have identified an underserved market, developed an application to facilitate the supply of the desired services, and found a pool of suppliers with the flexibility and motivation to provide such services. Now you can relax and let the invisible hand work its magic, or can you? You do not have to worry about contractor vs. employee classification, or do you? 

Well, life is not that simple, especially not in the wonderful state of California. Although you might see yourself simply as the middleman, connecting suppliers with consumers, the Employment Development Department (“EDD”) might consider you an employer with certain obligations to your labor “suppliers.”

Classifying workers as employees or independent contractors is one of the major headaches for companies – especially those operating in California. The development of service applications, such as Uber, Lyft, and Postmates, has created a high demand for services and provided employment for people seeking or needing flexible work. However, these developments in the market have also given rise to employment and tax law dilemmas, especially regarding independent contractor vs. employee classification.

What is AB-5?

In California, the enactment of Assembly Bill 5, commonly known as “AB-5,” has been the subject of great controversy, particularly within the tech industry. AB-5, which became law on January 1, 2020, revised the Borrello test by introducing the “ABC” test to determine an employee’s status and classification. Although the tech industry expressed the loudest opposition to this law, AB-5 has had repercussions in numerous and less conspicuous industries that have traditionally relied on independent contractors.  

Under AB-5, workers are generally considered employees unless they meet all three conditions of the “ABC” test:

1. The person is independent of the hiring organization in connection with the performance of the work, both under the contract for the performance of the work and in fact.
2. The person performs work that is outside the hiring entity’s business.
3. The person is routinely doing work in an independently established trade, occupation, or business that is the same as the work being requested and performed

The underlying factor in this test is the hiring entity’s control over the worker. If the worker only works for the hiring entity and the hiring entity directs the performance of the work, attempting to establish the independence of this worker will be extremely difficult.

Additionally, it is extremely important to remember that workers are considered employees by default, regardless of any agreements that might state otherwise. Therefore, the hiring entity has the burden to prove that the worker is in fact an independent contractor.  

Who is exempt from AB-5?

Luckily, there are numerous exceptions to AB-5. Proposition 22, which was approved by most California residents, exempts app-based drivers for network companies if the companies meet the conditions listed in Section 7451 of the Business and Professions Code. Primarily, these conditions address the network companies’ control over the drivers.

Currently, newspaper carriers and distributors are also exempt but only until January 1, 2022.

In other instances, the Industrial Welfare Commission, the Labor Code, and the Unemployment Insurance code explicitly define employment relationships that may be exempt from the ABC test.

Additionally, a worker could be classified as an independent contractor through the Borello multifactor test. This test takes into consideration several factors including, but not limited to, the worker’s investment in equipment, the need for special skills, the level of hiring entity’s direction over performance, and the parties’ perception regarding their employment relationship. When a court declares an exception to the ABC test, this multifactor test governs the determination of a worker’s classification in the applicable circumstances.

AB-2257, which modifies and increases exceptions to the ABC test and expands the use of the Borello test, went into effect on September 04, 2020. Under AB-2257, additional occupations and employment relationships are now able to use the Borello test, instead of the ABC test, to determine worker classifications if certain conditions are met. The new exceptions include, but are not limited to, the following:

• Business-to-business contracting relationships
• Referral agency and service provider relationships
• Contracts for professional services
• Single-engagement event contracts between two individuals
• Contracts with individual performance artists

In essence, AB-2257 relieved some of the tension created by AB-5 in the employment sector. However, it must be emphasized that numerous conditions must be met to bypass the ABC test and alternatively apply the Borello test. Although AB-5 may now be less intimidating, employers are advised to review and comply with both AB-5 and AB-2257 before making any independent contractor vs. employee determinations.

Why does worker classification matter?

As an employer, you have certain responsibilities toward your employees and the state. These responsibilities include paying California’s Unemployment Insurance and Employment Training Taxes, in addition to federal taxes. Also, you are required to obtain worker’s compensation insurance and, in certain situations, offer health insurance to your employees. Additionally, you are required to follow minimum wage and overtime regulations, and offer rest and meal breaks to your employees.

Hiring solely independent contractors is immensely desirable because the tax and insurance burden shifts from the hiring entity to the independent contractor. However, misclassifying workers purposely or unintentionally can result in multiple penalties and lawsuits.

Worker classification can be a complicated and costly matter, especially in highly regulated states like California. Nevertheless, do not let worker classification crush your entrepreneurial spirit!

If you are currently an employer facing issues regarding employee misclassification, reach out to the RJS Team as it is vital to have an updated independent contractor agreement in place before venturing into a non-employee relationship. RJS Law and its team of attorneys have the skills and experience to advise you regarding your situation and in drafting and reviewing independent contractor agreements.  RJS Law can also represent you before the EDD or IRS if you are being audited.

Published by Marcel Garcia

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