California recently passed the Assembly Bill 5 (AB5) law, an employment law that changes current worker classification as independent contractors and employees. The much-debated AB5 law takes effect on January 1, 2020.
In a nutshell, the AB5 law provides key protection for independent contractors who formerly did not receive the same benefits as regular employees.
Needless to say, this can have a huge effect on the way you do business with freelancers and other independent contractors.
Read on to find out more about the AB5 law, how it might affect your business, and what to do if it is.
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Events that led to the signing of the AB5 law
It’s undeniable that the nature of work has changed over the past few years. The gig economy is on the rise, and figures show that 15.8% of Americans participated in the gig economy workforce in 2015. That number has only grown exponentially.
The gig economy refers to the labor market typically characterized by short-term contract or freelance work. These gig-based jobs are made all the more available through technology-enabled work like ride-sharing apps and the like.
So things like Uber and Lyft employ gig economy workers, but this also applies to freelancers who render service in exchange for a fee.
Numbers show that 8.5% or nearly 2 million workers in California are signed as independent contractors – a much larger percentage than in the entire USA which only lands at 6.3%.
Image source: UC Berkley Labor Center.
The AB5 legislation resulted from the recent Dynamex case, which concluded in the California Supreme Court siding with the independent contractors who worked for the courier company.
After a series of hearings, the ruling found that Dynamex’s independent contractors should be considered employees, especially according to the ABC Test. (But more on that in the next few sections.)
What does it mean for small business owners?
Plainly put, for any business, regardless of size, the new law means additional costs and hiring.
The AB5 law in its current version obligates employers to pay a higher wage and overtime costs, while also mandating that said businesses are to contribute to unemployment and workers’ compensation insurance for independent contractors as well.
Companies operating in California that employ the services of independent contractors may also be faced with more frequent work, hour, and employment litigation.
Signs your business will be affected by the AB5 law
Will your business be affected by the new AB 5 law? Here are a few things to check.
The ABC Test
The AB5 law will uphold the three-part ABC Test, a guideline that helps employers classify their workers as either employees or independent contractors.
According to the ABC Test, a worker is considered an independent contractor if the worker is proven by the employer or hiring entity to be:
- Free from the control and direction of the company or hiring entity;
- Performing work that is outside the company or hiring entity’s main business; and
- Normally engaged in an independently established trade, occupation, or business of the same nature as the work performed for the company or hiring entity.
If the formerly independent contractors meet all three criteria for reclassification, they may now be entitled to the following benefits as employees:
- A minimum wage
- Workers’ compensation
- Unemployment insurance
- Expense reimbursement
- Paid sick leave and paid family leave
- Opportunity to join a union
Employers must also pay half of the employees’ Social Security tax after the bill takes effect in January 2020.
Setting up a business in California
For current small businesses already in operation, you may face additional hurdles due to the new law.
The AB5 law might mean making major readjustments in your current business model to accommodate new workers or to adapt and find more cost-effective measures.
It’s also necessary to figure out how your business will be paying for the reclassifications. While large companies might be able to ease into it, for a small business, it’s not so easy to suddenly have to give freelancers the same benefits as full-time employees.
One possibility may include passing on the new cost to your customers, meaning increasing prices of your products and services, but this, of course, may not always work well. The only other alternative at the moment is absorbing the additional reclassification cost as a business expense, but this could be a hefty loss.
You’ll need to be aware of the law and its implications especially if you’re planning to set up a new business or are making readjustments to your business model.
Say before the passage of this new law, you had been planning to put up a Software as Service (SaaS) company – maybe because its relatively short-term cost savings, scalability, and resilient hosting service appealed to you, and you had a good idea on what kind of software to create and market.
If you were planning to hire independent contractors – and with SaaS businesses, especially, where you would normally hire independent contractors for developing the software, doing customer service, doing sales, etc – to help you put up and run your business (and you’re based in California), you’d want to pay attention to the stipulations of the AB 5 law to see if your workers are classified as employees or not.
Hiring freelancers in California
Over the years, more and more businesses and companies preferred hiring freelancers, mainly for a host of benefits for both parties. We can probably pin this rising trend to how fast technology has advanced over the past couple of decades.
For example, these days, it’s not uncommon for people to do frequent video conference calls with freelancers halfway across the world or to use what’s called cloud phone systems, which have allowed companies to hire freelance customer support agents and virtual assistants.
Recalling our previous example about the SaaS company in California, say you wanted to hire a freelance web developer in your area to create the website where you’d sell your software idea.
In this case, you’d prefer the developer to be an independent contractor instead of a full-time employee. After all, after they’ve set up your site, most of the work you may require from them involves minimal maintenance – or work that takes only a few hours a month.
Once the AB5 law is enacted in January, you’d need to ensure that this independent web developer is working on tasks that aren’t central to your business, lest they be considered regular employees.
If most of the work is central to your business, you’d need to reclassify them accordingly.
You can always, of course, consider outsourcing administrative tasks like managing and publishing on your company’s social media page, or tasks that don’t cover your business’s line of expertise, such as bookkeeping if you’re not an accounting firm.
Exemptions to the rule
While it seems like the new legislation covers absolutely every kind of independent contractor out there, it doesn’t affect professions in various industries that are still considered independent contractors according to the ABC test.
These include doctors, insurance agents, stockbrokers, real estate and travel agents, lawyers, graphic designers, freelance writers, and several other professions.
Notably, ridesharing and delivery companies like Uber, Lyft, and DoorDash insist they’re not covered by the new AB5 law.
You’re covered. Now what?
So your business is based in California or you’re working with independent workers in the state.
First thing you can do? Lawyer up. If you think your business might be affected by AB5, get an employment law attorney to examine the classification of your current workers.
While the AB5 will affect all companies that rely on independent contractors solely in California, we know from previous experience that whenever a new law is passed in California, other big city-states like New York and Washington may just be one step behind.
AB5 also means additional business costs and a potential adjustment to your business model. However, failure to comply with AB5 has significant legal ramifications as well.
Your business could be fined, penalized, or face litigation. That’s why it’s best to be guided by a skilled lawyer along the way.
The AB5 will be implemented by January 2020, and its supporters are looking forward to receiving the benefits that the new law promises. However, many employers and workers are still in the dark about how the AB5 will affect them. But for now, the AB5 means added costs to businesses and potentially the loss of the much-desired flexibility for contract workers. While the future is unclear for independent work in California, it doesn’t hurt to be prepared and stay one step ahead of the law.