California Passes AB 5 Bill, Impacting Worker Classification

At a Glance

• Effective date January 1, 2020 
• Affects employers who have independent contractors performing work in California
• Clarifies that a worker is an employee unless a hiring entity satisfies a three-factor “ABC Test” 
• Employers with certain 1099 workers will need to convert these workers to W-2 employees
• Beginning on July 1, 2020, all workers defined as employees must be covered by workers’ compensation insurance
• Provides exemptions from the test to certain professions and business-to-business relationships

Introduction

On September 11, 2019, the California lawmakers passed AB 5, Worker Status: Employees and Independent Contractors. Governor Newsom has recently announced his support of the bill and we anticipate that he will sign the bill soon. The bill makes significant changes on how worker classification is determined and once signed, AB 5 will incorporate the “ABC Test” as part of California employment code. The ABC Test is a three-pronged standard to determine whether a worker is an independent contractor instead of an employee. Under this standard, a worker is considered an employee unless each of the three requirements below can be met in order to classify the worker as an independent contractor.

1. 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.
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 for the hiring entity.

Background

California AB 5 stems from a 2018 California Supreme Court decision, known as Dynamex Operations West, Inc. v. Superior Court, which redefined the definition of employee and put in place a new standard for classifying workers as independent contractors. Under the Dynamex decision, organizations must apply the ABC Test to determine if a worker can be classified as an independent contractor.

AB 5 Worker Status: Employees and Independent Contractors

California AB 5 makes several amendments to the California Labor and Unemployment Insurance Codes. Once effective, many workers who were previously classified as independent contractors will be eligible for employee and unemployment benefits, such as:

• Social Security and Medicare withholding, including the employer portion of each
• Minimum wage and overtime requirements
• Protections under FLSA and state wage and hour laws
• ACA offer of coverage
• State unemployment tax contributions
• Workers’ compensation
• State and local paid sick leave requirements
• Paid family leave requirements
• Statutory Disability Insurance

Several professions are exempted from AB 5, including doctors, dentists, insurance agents, accountants, engineers, travel agents, and so on. Generally, these exemptions apply to professions where the worker sets their own prices directly with their customers. 

Next Steps

Employers who have workers in California should take steps now to audit their workforce to ensure workers are correctly classified. For additional information about AB 5, please see article “CA AB 5 FAQs.”

Thank you for choosing Paylocity as your Payroll Tax and HCM partner. 

This information is provided as a courtesy, may change and is not intended as legal or tax guidance. Employers with questions or concerns outside the scope of a Payroll Service Provider are encouraged to seek the advice of a qualified CPA, Tax Attorney or Advisor.