CA Passes Law to Avoid Misclassification of Employees

On September 18, 2019, Gov. Newsome signed AB 5 into law. The new law codifies the decision of the California Supreme Court in Dynamex Operations West, Inc. v. Superior Court of Los Angeles, 4 Cal.5th 903 (April 30, 2018). Prior to the ruling, the determination of whether an individual was an independent contractor or employee was based on a totality of facts analyzed through a multiple-factor standard. The Superior Court established a new three prong test, commonly known as the ABC test. Effective, January 1, 2020, AB 5 codifies these provisions into California law. (See our May 15, 2018 article in Compliance Corner for more information.)

California workers are presumed to be common law employees. They can only be classified as independent contractors if they satisfy all three of the following conditions:

  • 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 facts
  • 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.

The law provides many exemptions from the requirement, including the following:

  • California licensed insurance agents
  • Physicians, surgeons, dentists, podiatrists, psychologists, or veterinarians performing professional or medical services
  • Lawyers, architects, engineers, private investigators, or accountants who have an active California license
  • Securities broker-dealers or investment advisers or their agents and representatives that are registered with the Securities and Exchange Commission or the Financial Industry Regulatory Authority or licensed by the State of California
  • Direct salespeople
  • Commercial fishermen working on American vessels

The previous multi-factor test will still apply to certain professional services contracts where the worker meets the following conditions. Professional services includes marketing, human resources, graphic design, travel agency, grant writer, photographer, freelance writer, and licensed manicurist. The worker must:

  • Maintain a business location separate from the hiring entity’s location, which may be the worker’s residence
  • Have a business license, in addition to any required professional licenses (effective July 1, 2020)
  • Have the ability to set or negotiate their own rates
  • Have the ability to set their own hours
  • Have contracts with other hiring entities or hold themselves out to other potential customers
  • Customarily and regularly exercise discretion and independent judgment in performance of services

The stated purpose of the law is to reduce the harm caused to misclassified workers who miss out on payment of payroll taxes, workers compensation coverage, Social Security contributions, unemployment insurance, and state mandated disability insurance. Thus, the law doesn’t directly change eligibility for group health plan coverage under ERISA or the ACA’s employer mandate. However, an employer will need to carefully consider the classification of a worker as an independent contractor or a common law employee.

The employer mandate requires large employers (those with 50 or more full-time employees, including equivalents) to offer minimum value, affordable coverage to common law employees working 30 hours or more per week. If an independent contractor will be reclassified as a common law employee, the large employer will likely need to offer them coverage if the employee is working full-time hours. Otherwise, the employer could be at risk for a penalty under the employer mandate. Depending on the percentage of affected workers, the employer could be at risk for the more costly Penalty A for failure to offer coverage to substantially all full-time employees (95%).

An employer who wishes to review their employee classifications should contact outside counsel. If workers are found to be misclassified, there may be previous tax liability and filings to be addressed as well as future benefit offerings and labor law protections.

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