Who’s the boss? The AB 5 laws

Formations Team

22 Jun

In the last two decades, more and more people become independent contractors. Being your own boss might be promising and companies that hire your services will surely find many advantages in working with contractors. But when wearing labor law glasses, if someone hires your services, are you really an independent contractor or an employee?

Am I an employee or an independent contractor?

There are two options to perform services for a company – become an employee or work as an independent contractor. Both an employee and an independent contractor may perform the same work, but worker classification is very important for legal and tax purposes.

As an employee you get paid a regular wage, you receive employee benefits, and your employer must withhold income taxes, pay social security, Medicare taxes, and unemployment taxes on your wages. The employer controls the work performed by the worker in all aspects.

Independent contractors are usually getting paid per project. As an independent contractor, you are considered self-employed and your earnings are subject to self-employment tax. Independent contractors usually set their own hours and decide how and when to perform their work.

To better understand how to properly classify a worker, the IRS has established a three categories test to assess the relationship between the parties: Behavioral Control, Financial Control, and Relationship of the Parties.

Behavioral control- Who is controlling the worker’s time, work-life, and tools to perform the work?

Financial control- Does the worker get paid a regular wage amount for a determined period or a flat fee per project? Who owns the equipment that the worker is using? Can the worker perform work for other businesses as well?

Relationship of the parties- Is the worker hired to perform services that are outside of the scope of your business? Is it a short-term contract?

Currently, about 40% of the workforce in the US are self-employed. Many people are working part-time or taking temporary positions, evolving what we call the gig economy. On one hand, this may benefit workers, businesses, and consumers by making work adaptable to the need and demands of the current lifestyle. On the other hand, it creates cheaper and more efficient services that may result in workers’ exploitation. This situation requiring us to constantly examine the work laws dealing with relationships between workers, businesses, and clients.

Recent AB5 law clarifying who is considered an independent contractor by law.

In May 2018 the CA Supreme Court made a landmark decision in the classification of an independent contractor (Dynamex Operations West Inc. V. Superior Court). The court determined that most workers are considered employees and are eligible for workers protection (minimum wage, sick leave, unemployment, worker’s compensation benefit, etc.). The proof for classifying individuals as independent contractors belongs to the hiring entity. On September 2019 the California Assembly Bill 5 was signed into law, and Effective January 1, 2020, hiring entities are required to classify workers as employees unless they meet all conditions of the ABC test:

  1. The person is free from the control and direction of the hiring entity 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 usual course of the hiring entity’s business.
  3. The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Over 50 professions or types of businesses are exempt from the bill, among them are doctors, dentists, insurance agents, lawyers, accounts, real estate agents, hairstylists, and a variety of creative professionals. An exemption doesn’t mean you’re automatically an independent contractor. It means you’re exempt from the ABC test. In this case, the hiring entity must demonstrate that all the following factors are satisfied:

(A) The individual maintains a business location, which may include the individual’s residence, which is separate from the hiring entity. Nothing in this subdivision prohibits an individual from choosing to perform services at the location of the hiring entity.

(B) If work is performed more than six months after the effective date of this section, the individual has a business license, in addition to any required professional licenses or permits for the individual to practice in their profession.

(C) The individual can set or negotiate their own rates for the services performed.

(D) Outside of project completion dates and reasonable business hours, the individual can set the individual’s own hours.

(E) The individual is customarily engaged in the same type of work performed under contract with another hiring entity or holds themselves out to other potential customers as available to perform the same type of work.

(F) The individual customarily and regularly exercises discretion and independent judgment in the performance of the services.

While this law was formed and signed in CA, some other states have already followed the suit and enacted similar laws making it even more difficult to classify workers as independent contractors.

I want to be considered an independent contractor!

Yes, there are many benefits to independent contractor status. The best part is probably working for yourself and controlling your work pattern and schedule. How will you make sure that you are considered a contractor by law and make it easier for any entity that wants to hire your services?

You must act and behave like a business!

-Form your own LLC, an independent entity that is separate from you. Hiring entities will hire your company to perform services.

-Have a proper contractor agreement signed between your business and the hiring entity.

-If your profession requires licensing, make sure you are properly licensed and certified to perform your services.

-Establish your own place of work, this could be either your home office or a place that you rent. Any place that is separate from the hiring entity would help you show that you are acting independently.

-Pay your taxes as a business with proper EIN number (EIN is Employer Identification Number which the IRS uses to identify your business).

Formations is here to help you!

We are here to help you manage your business as a business. We will guide you through opening your own LLC and will keep your business Compliant with the IRS. We are here to help transform full-time independent workers into small businesses. Following onboarding, Formations provides automatic tax management, bookkeeping, and payroll solutions while ensuring full compliance with federal and state agencies, including incorporation and actual tax filings. Not our customer yet? Reach out to us, we are here to help

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