A new California law aimed at worker classification may have a significant tax impact for companies. Understanding the difference between an employee and independent contractor and the tax consequences that flow from each designation should be top of mind for business owners and those within the payroll and tax departments at companies with a traditionally independent contractor workforce.
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Assembly Bill 5 was aimed at businesses in the “gig economy”, like Uber, Lyft, and the like. Gig economy workers were generally considered independent contractors and not employees of the companies for which they worked. Companies like Uber viewed their platform as merely a service that connects riders with drivers, instead of playing the role of employer to their thousands of ride-providing resources.
Proponents of A.B. 5 view the gig economy as potentially abusive to workers. They generally cite the lack of benefits or a minimum wage guarantee. Because independent contractors are not considered employees, they do not receive sick leave, vacation time, medical benefits, or workers compensation protection. Gig economy companies insist that changing the law to classify the workforce that utilize their applications as employees would cripple the business model. Nonetheless, California lawmakers decided that a rewrite of the worker classification rules was in order.
Effective January 1, 2020, A.B. 5 lays out a three-part test in determining whether a worker is an employee or an independent contractor. The goal of the test is to analyze the control and supervision a company exerts over a worker, as well as the type of work that is being performed. A worker will be considered an employee (and not an independent contractor) unless all of the following three tests are met:
Effectively, the three-pronged test of A.B. 5 requires a company to look at its relationship with the resource and determine whether it is of the type that is typically seen between an employer and employee. The first prong of the test involves control, which has been a long-standing element of worker classification. But the second and third prongs of A.B. 5 look to the core functions of the business and the independent business activity of the worker.
If an IC does not meet these three requirements, and they are not included under “carve-out” exclusions to the law, the IC may need to be reclassified as an employee. It important to understand that carved out professions are not truly exempt from all IC requirements. They are simply exempt from the ABC Test, which means that contractors must still be qualified under the previous multi-factor Borello Test as well as the new factor tests detailed below that apply to each exception category.
The factors of the Borello test are as follows:
The Carve Outs land in three different buckets:
1. Recognized or Specifically Named Professions,
Physicians and surgeons, dentists, podiatrists, psychologists, veterinarians, lawyers, architects, engineers, accountants, broker-dealers, investment advisers, direct salespersons, private investigators and commercial fisherman.
2. Professional Services
To be exempt under this bucket, the professional service providers named below must meet six specific service requirements:
Professional Service Providers include: marketing contractors, human resources administrators, travel agents, graphic designers, grant writers, fine artists, enrolled tax agents, payment processing agents, still photographers or photojournalists, freelance writers, publication editors and newspaper cartoonists.
Generally, the exceptions apply to companies with professionals who are independently credentialed and maintain licensure. For instance, doctors, dentists, and psychologists (among others) are excepted from the A.B. 5 test. This is likely because the professionals subject to the exception, by the nature of their position, exert the requisite independent judgement and control needed to establish their contractor status. Additionally, A.B. 5 was enacted to prevent the perceived abuse of workers in the gig economy who were traditionally independent contractors.
Professional service providers are likely not the type of individual that lawmakers had in mind when they crafted the protections resulting from A.B. 5.
It is also important to note that several bills are currently being floated around the California Legislature that are intended to further modify A.B. 5 so this area of law is at present a moving target.
Business-to-business contractors are carved out if they meet the following specific criteria:
This exception is quite lengthy and chock full of factors to satisfy. Businesses would be wise to see how well they can compose or adjust their IC engagements to fit within this exception, if possible.
A.B. 5 will require businesses who utilize those who would have been traditionally considered independent contractors to reassess worker classification statuses. If a company is deemed to have employees instead of independent contractors, that company will be required to pay employment taxes on the wages paid to employees. Companies deemed to have employees under A.B. 5 will also be required to withhold, account for, and pay over payroll taxes. A myriad of non-tax repercussions are also at play, including minimum wage requirements, workers compensation insurance, and any required medical coverage, among many other considerations
Although the A.B. 5 test seems simple enough, there is plenty of opportunity for planning and business structuring to help mitigate impact of A.B. 5. Additionally, the exceptions and exemptions of the new legislation oftentimes require detailed analysis and advocacy. If you are a business owner who may be affected by A.B. 5, it is in your best interest to consult with an experienced employment attorney to determine the full impact of the new law and determine whether you qualify for an exemption or exception.
The tax and accounting professionals at the Tax Law Offices of David W. Klasing have extensive experience representing a diverse group of taxpayers. From individuals to middle market businesses and beyond, our team of zealous advocates will assist in the development of a strategy to help you reach your specific goals and objectives. Whether you are under a tax examination or are in need of tax planning advice, contact the Tax Law Offices of David W. Klasing today, online or by phone at (800) 681-1295, for a reduced-rate consultation.
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