Independent Contractors vs. Employees: What California’s New Law Means for Your Business
*The following article was updated in March 2024*
California’s new law, Assembly Bill (AB) 5, went into effect on January 1 of this year, and it’s already raised several questions for both companies and independent contractors about what it means for their future business dealings.
AB5, also known as the “The Gig Worker Bill,” determines whether California workers are employees or independent contractors, and that a strict ABC test be used to determine how those individuals are classified. The classification impacts how employees are paid with respect to minimum wage, overtime pay, unemployment insurance, workers’ compensation insurance, and paid family leave.
Under the new law, more workers would be classified as employees than independent contractors, which impacts the company that is hiring them. This affects tens of thousands of workers and independent contractors in San Francisco, including Uber and Lyft drivers, freelance writers and journalists, freelance videographers, and many more.
The new law applies to nearly all California workers, but the burden of proof is on the employer to demonstrate the worker is an independent contractor or employee. Essentially the employer needs to show whether they have control or the right to control the worker, and how the individual chooses to complete the work. For a person to be considered an independent contractor, all three of the following conditions in this ABC Test must be met:
- The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact
- The worker performs work that is outside the usual course of the hiring entity’s business
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity
If a worker does not meet any one of the three criteria, the business must classify them an employee.
What AB5 Means for Employers
California generally encourages workers to be classified as employees to protect them. They want the worker to be covered by worker’s compensation and have the right to collect unemployment if they were to lose their job. As a result of this, the California Employment Development Department (EDD) is getting stricter with conducting re-classification audits, which essentially determine if a contractor should be considered an employee.
This is significant because business the EDD can personally assess the business owner for “unpaid” payroll taxes because the EDD has determined that they believe these workers are actually employees. So if you’ve ever hired an independent contractor, you could be facing this tax audit and possible financial penalties.
Since AB5 is new, there is still much to learn about how it will affect businesses and independent contractors. Talk to an experienced San Francisco attorney or tax professional who can help you understand how the situation impacts you; so you as the taxpayer or business owner is protected and receives the best possible outcome.
Allison Soares is a partner and tax attorney at Vanst Law. It doesn’t matter the issue: audits, collections, appeals, international disclosures, grumpy people— Allison enjoys fixing problems. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits.
