What small businesses need to know about AB5

An illustrated magnifying glass is hovering over the words AB5

Last year, the California state legislature officially passed California Assembly Bill 5 (AB5), also known as the ‘gig-worker law,’ permanently altering how workers are classified in the state. Let’s dive into what the law means and how it’s likely to impact your business.  

WHAT IS AB5?

Effective January 1, 2020, AB5 is a new California employment law that can create significant financial liability for companies that don’t understand it.

In the past, companies could choose to hire and classify workers as employees or independent contractors, based on a number of factors. The rules are very different for these two categories, but it is typically much less expensive to hire an independent contractor instead of an employee. 

For example, employees are usually eligible for certain employment benefits including overtime, healthcare, retirement, and unemployment insurance. Employers have numerous payroll tax responsibilities for their employees. On the other hand, independent contractors are usually ineligible for any employee benefits, are paid by the job or by the hour, and are responsible for remitting their own taxes.

Basically, AB5 redefines the employment status of workers to potentially include many workers that were previously categorized as “independent contractors,” (1099 contractors) re-categorizing them as “employees” (W-2 employees) instead of independent contractors.

Now, under the rules of AB, all workers are presumed to be W-2 employees of a company unless the employer can demonstrate that the workers are 1099 independent contractors under the so-called “ABC TEST” in California.

WHY WAS AB5 PASSED?

The rise of the “gig economy” has led to the rapid growth of companies like Lyft, Uber, Airbnb, Amazon Flex and others. These gig companies hire large numbers of “gig workers” as independent contractors, avoiding the traditional costs associated with hiring employees. Some lawmakers and other influential people believe that gig workers are being taken advantage of because they are being forced to work without the benefits typically enjoyed by an employee. In order to correct this perceived inequality and bring fairness to the playing field for all workers, AB5 seeks to redefine most workers as employees, thereby boosting their benefits under the law.

WHO IS EXEMPT FROM AB5 LAW?

At the most basic level, if your company is not located in California, doesn’t hire independent contractors working in California, or doesn’t have independent contractors who regularly travel to California for business, you are likely beyond the reach of AB5.

However, if your business regularly hires and uses independent contractors in California, then you should learn more about AB5, so you can determine whether or not you need to understand and comply with its requirements.

Even if you’re currently exempt from AB5 compliance, you should still be aware of the ramifications of AB5 because a number of other states are considering similar legislation.

WHAT IS THE AB5 ABC TEST?

The ABC test is based on the litigation in the Dynamex case, which was decided by the California Supreme Court in 2018. The ABC test is a test employers must pass before they can classify a worker as an independent contractor and not an employee. Under AB5, the default status of a worker is as an employee unless the employer can meet the specific guidelines outlined in the three-part ABC test. Employers are responsible for the correct categorization of workers or they might face costly fines.

Under the Dynamex ruling, a worker can only be properly classified as an independent contractor if they met each of these three factors:

  1. The worker is free from the control and direction of the hiring entity in connection with the work’s performance, both under the contract for the performance of the work and in fact.

  2. The worker performs work that is outside the usual course of the hiring entity’s business.

  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

WHAT IS THE IMPACT OF AB5?

Interestingly, not all independent contractors are excited about becoming employees. As independent contractors, they could choose their hours, the days they worked, and how much they worked. Once they are classified as employees, much of the freedom to control their schedule may be lost. Part-time Uber and Lyft drivers, for example, may be required to drive eight hours a day or take late afternoon or evening shifts. Since many Uber and Lyft drivers already have full-time jobs or are students, this could eventually force them to choose between these competing priorities.

AB5 does provide exemptions for certain professions and occupations. Lawyers, doctors, dentists, hair stylists, accountants, insurance agents, engineers, real estate agents, financial advisers and some health care workers are included as being exempt from compliance with AB5. 

Although there are a number of exemptions written into AB5, the exemptions seem somewhat arbitrary and may not provide much relief. For example, under AB5, a freelance journalist may publish up to 35 articles a year with a publication. Given this limit, some freelance writers have been hard hit by the passage of AB5 because they would write more than 35 articles a month. SB Nation, owned by Vox Media, announced in January of 2020 that they would be laying off hundreds of contractors—the majority of whom would not be rehired as employees—in order to comply with AB5.  

IS AB5 BEING CHALLENGED?

It is likely there will be some changes to AB5 in the near future. As with many laws, the unintended consequences are already being felt. Many employers are cutting ties with California-based independent contractors and out-of-state employers are screening independent contractors to ensure they don’t live in California.

A federal judge in San Diego issued a preliminary injunction against the enforcement of AB5 for trucking companies. The judge’s ruling means the state of California cannot implement AB5 as it pertains to the trucking industry.

There is at least one remedial measure slated for the November ballot in California. Uber, Lyft, and DoorDash have united their efforts to get Proposition 22 in front of the voters. Proposition 22 would allow rideshare drivers to be classified as independent contractors while providing some enhanced employment benefits.

At the most extreme end of the spectrum, California Assemblyman Kevin Kiley (R-Rocklin), is trying to get a ballot initiative in place to repeal the law. The ballot measure would aim to strip AB5 from statute in the 2022 election. Since there is no real push behind this initiative, it’s unlikely to make it on the ballot this year.

BOTTOM LINE: IF YOU’RE IN CALIFORNIA, YOU MUST CLASSIFY

It would appear that AB5, in some form, is likely to be around for at least the immediate future. As a business owner, you should at least take a hard look at your current situation if you routinely use independent contractors in your daily business operation. You would want to evaluate each independent contractor to see if you can still qualify them as an independent contractor. If not, you may need to hire them as an employee or let them go in order to be compliant with AB5.

Disclaimer: Yes, I’m a lawyer, but I’m not your lawyer. All information in this post is provided for educational purposes only and should not be considered legal advice for any specific person or specific situation.

About the author

Mark F. Wright, JD

Mark has extensive experience in the practice of law, business management, and engineering in a wide variety of corporate, government, and private sector environments. Mark has successfully assisted various small companies as well as Fortune 500 companies in developing their patent, trademark, and technology licensing portfolios, specializing in emerging computer hardware and software technologies.

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