California Assembly Bill 5 - AB5 - Effect on Independent Contractors

People may notice several changes in state and federal laws every year. Some people don't seem affected by these changes, while others are affected significantly. Even though some of these new laws may not affect all individuals like others, many common people may be affected significantly. California Assembly Bill 5 is one such bill that affects independent contractors or freelancers.

The AB5 was made to protect people who work in the usual course of the gig economy. Still, it severely affects many other industrial relations, including the gig economy.

California Assembly Bill 5 or AB5 has created a lot of same nature cases, confusion, and queries. If you are a freelancer living in California, you may be personally affected by this California law and have doubts about it. Even if you don't live in California, you still feel the effects if you work as a freelancer for a California-based company.

In this article, we will discuss the basics of AB5, all the related issues common California workers face, and their solutions. If you're worried about how this law will affect you, it is wise to consult an attorney or a financial accountant and ask for help.

What is AB5?

Assembly Bill 5 (AB5), a.k.a "The Gig Worker Bill," is a law in California that went into effect on January 1, 2020. It changes how businesses classify their workers. The bill says businesses hiring freelancers, gig workers, and contractors engaged in independently established trade occupations must reclassify them as employees if their jobs and responsibilities meet specific criteria. Employers must use the ABC test to determine how to classify a worker.

The main thing that could lead to a reclassification is if the employee is essential to the business, which means that the company could not run well without that employee (or job). However, there are exceptions to this rule in which an employer wouldn't have to change a worker's status from independent contractor to employee.

Employers divide their employees into one of two groups:

When a company hires you to provide professional services, it must decide whether you're an employee or an independent contractor. This is quite significant because tax laws, labor laws, and other laws treat employees and independent contractors really differently.

An Employee

You're an employee if you don't have your independent business; you work for someone else. Payroll is how employees get paid, and payroll taxes are taken out and paid by the company. State and federal labor laws give workers a lot of rights. For example, they should be paid no less than the minimum wage, and many of them have to be paid time and a half for overtime.

An Independent Contractor

You are an independent contractor if you own a business or trade. You sell your skills to more than one client or customer and don't work for or answer to any of them. Independent contractors do not earn through a payroll system. They are getting paid by clients or customers directly. Contractors pay their own taxes and don't have any taxes taken out of their pay. They pay taxes on their net income from self-employment, which is the amount of money they make minus the taxes they pay. Employees don't get tax breaks for their business. 90

Independent contractors have hardly any rights under state and federal labor laws because they are their own companies. For example, minimum wage laws don't apply to them because they don't work for a company. The only "rights" an independent contractor has against a client or customer are those written in the contract.

Classifying workers is not a new idea, but AB5 makes it more challenging to classify a worker as a contractor than it used to be. It's a way for California to protect gig economy workers who work as employees but don't get the rights or perks of employees.

Why AB5 came into effect

AB5 came into effect because of a 2018 case called the Dynamex case. In that decision, the California Superior Court said that companies must use a three-part test, often called the ABC test, to determine if someone is an employee or a freelancer. AB5 was passed by the California Supreme Court to make the Dynamex decision official.

The Massachusetts Independent Contractor Law, which went into effect in the 1990s, is what made the ABC test possible. The Massachusetts law was made so that the state could determine who could get unemployment workers' compensation benefits. This strict test is partly because the IRS rules about who is and isn't an employee aren't always clear.

The ABC test assumes that a person is an employee unless the company can show that:

  • The individual is customarily engaged in his or her job without being controlled or told what to do by the company.
  • The worker performs work independently, and the job falls into a category that is outside the usual course of the hiring company.
  • The person is doing the tasks that are part of his or her daily duties, jobs, or business.
  • Sometimes, a fourth condition says the contractor must be in business for themselves. Most of the time, this can be shown by the person with a state business license. Some examples are investment advisers, licensed healthcare professionals, registered securities broker-dealers, etc.

What if you work as an employee under AB5?

As per AB5, if you are considered an employee, the company that hires you must:

  • Follow the California unemployment insurance code and labor code provisions.
  • Give you unemployment insurance benefits and pay the employment training tax and California unemployment insurance taxes.
  • Give your workers' compensation insurance coverage.
  • Take out state disability insurance taxes from your pay.
  • Take out personal income taxes from your pay and send them to the California Franchise Tax Board.
  • Offer you paid family leave for up to six weeks.
  • Give you the minimum wage.
  • Offer you a minimum amount of paid sick leave each year.
  • Pay you time-and-a-half for overtime over eight hours per day or 40 hours a week (except administrative, executive, or professional jobs).
  • Pay you back for out-of-pocket costs you have to pay for your job, like driving costs.
  • Give you breaks for meals and rest.
  • Pay you for any unused leave time when your job is over, and follow California's paycheck rules.

A lot of this sounds good, except for the part about delaying. But many companies that hire people don't want to pay these extra costs. So, they might not hire you and instead hire someone from outside California.

How the ABC test works

The ABC test is a classification process for freelancers. It puts you in a group based on how you work. Employers are required by law to group their workers based on this test. You should know about this even if you don't live in California. The ABC test is partly based on how the IRS defines workers.

To be called a contractor, a worker must qualify for all three parts of the ABC test:

A) The worker is not under the employer's control or direction, both legally and in real life. This includes three types of control: behavioral, financial, and over relationships.

  • Behavioral

    This means the person who hired you can't tell you how to do your job. They can pay you to create something, like a website, but they can't tell you how to make it when you work or what you do during the day. The only thing the hiring entity or a company can do is accept or reject your job.
  • Financial

    The person who hired you can't decide everything about money in your relationship. This includes how much they pay you, when, and how and if they pay your costs. Whose goods or tools you use on the job is another way to keep track of money. You are probably an employee if you only use the tools and supplies the hirer gives you.82
  • Relationship

    Does the client let you work for other people? If not, you're probably an employee. This control also considers how long you plan to stay in your job. If the person who hired you wants to work with you for a long time, not just for a short assignment, you might be an employee.

B) The person does work outside the business of the hiring entity.

In other words, your work isn't necessary for the hiring entity's business to run or make money. You must not do the same job as the hiring company's regular workers.

For example - if you render social media marketing services and your hirer is a publisher, you'll be considered an independent contractor. However, if you have a bookshop and sell only books published by the publisher, you'll be regarded as an employee.

C) The worker usually works in an independently established trade, profession, or business similar to your work.

You must have a real business that is steady and well-known. You may describe this in many ways:

  • Have money invested in the industry and be able to lose money.
  • Have your own office or place of work.
  • Have all the business licenses you need.
  • Have the tools you'll need to do your job.
  • Recruit helpers.
  • Advertising, such as having a listing for your business in an online directory.
  • Work for different hiring companies at the same time.
  • Pay people by the job instead of by the hour.
  • Maintain business liability or workers' compensation insurance.
  • File federal income tax forms for a business (IRS Schedule C).

You don't need to fulfill all the factors on this list. But the more you do, the more you look like one of the independent contractors. Forming an LLC or incorporating your business are good ways to show that you have a separate company. Remember to be an independent contractor to pass all three of these tests.

What are the exclusions and exceptions of the ABC test?

AB5 doesn't apply to all California employees, gig workers, or independent contractors. There are a few things that don't fit the ABC rule. But these exceptions only apply in certain situations and to specific jobs. Some of these jobs are:

  • Surgeons, dentists, psychologists, and even vets.
  • Insurance brokers.
  • Lawyers.
  • Engineers and architects.
  • Accountants.
  • Marketing professionals (in some circumstances).
  • Travel agents.
  • Graphic designers.
  • Grant writers.
  • Photographers, photojournalists, writers, editors, and cartoonists.

(limited to 35 submissions to a single publication a year)

There are also other jobs, such as construction and real estate. But you must have the proper licenses or certifications in your area to be in any of these groups.

Not only must an employee work in one of the exempted areas, but the job must also pass the Borello test. Like the ABC test, the Borello test has 12 things that a hirer must consider when deciding whether someone is an employee. But, unlike the ABC test, the Borello test does not require a person to meet all 12 factors to be considered an independent contractor or an employee. Each factor is considered separately, but they are all important to the job.

But, like with the ABC test, one of the most essential parts of the Borello test is whether or not the employer has power over the work and how it is done.

Some freelancers couldn't get new jobs because companies were less likely to hire freelancers from California. Even if a business is not in California, AB5 rules still apply if the freelancer lives in California. This means that a company not based in California must execute the ABC test on all freelance hires.

Many people didn't understand AB5, so in September 2020, the law was changed to AB2257. It took action right away and included several changes.

As was said above, AB5 didn't apply to several jobs. The new bill makes it possible for freelancers to work in these fields:

  • Music (including songwriters, composers, recording artists, sound mixers, etc).
  • Performing arts.
  • Underwriters (those who provide inspections, audits, risk management, or loss control services).
  • Appraisal services.
  • Home inspectors and manufactured housing salespeople.
  • Professional forester.
  • Professionals in charge of international exchange programs.
  • Competition judges.

AB2257 removes the 35-submission cap for writers, photographers, photojournalists, and editors. It also explains business-to-business relationships and what occurs when two freelancers work together to provide services.

How can you preserve your career as an independent contractor?

Some people think that AB5 is a good thing for the gig economy. But for some, AB5 threatens their position as independent contractors and the benefits that come with it. One of the best things about being your own boss is that you can choose how and when you work. When you work for someone, you sacrifice that freedom.

Many companies are now afraid to hire freelancers from California out of fear that they will misclassify their workers.

But before you wear a suit and say you'll never be a freelancer again, you should know that all is not lost. You can do a few things to protect your status as an independent contractor and keep your lifestyle of working from home.

1. Create a business entity

Most freelancers are sole proprietors. You are the business when you run a business as a sole owner. You should instead create a business company that will own and run the operation. In a legal sense, your business will then be a different entity from you. With AB5, this is very important because people no longer hire YOU; they hire the company. You can get a business-to-business tax break by making a separate business entity.

A single-member limited liability company (LLC) is the type of business that most freelancers use. But you can also start a corporation. You can be taxed as an S Corp or a C Corp. To make an LLC or company, you must register with the Secretary of State in your state and be on record as a business.

Creating an LLC or corporation costs more money upfront but will pay off in the long run. You'll appeal more to clients and have an advantage over freelancers who work independently.

2. Get a license to do business

Even if you don't incorporate, you still need a business license. You need a business license to meet a lot of the exemption requirements. The person who hires you has to show that you are a contractor. The more proof you give them, like a business license, the more likely they will hire you.

3. Get an EIN

The IRS uses a federal employer identification number, or EIN, to recognize your business. Even though it says "employer" in it, anyone, even a sole proprietor, can apply for an EIN.

Using an EIN is good as a sole proprietor because it saves your social security number. Plus, it makes you even more of a business on your own.

4. Have your own place of work

Every criterion for an exemption in AB5 talks about having a different location for the business. When deciding whether you are an employee or a contractor, the IRS and California look at where you work. They intend to ensure you don't depend on the person who hired you.

But you don't need to rent a big office to have a place for your business. As long as you work there, your home can be a place where you do business. It is essential to show that you always work for your clients somewhere other than their office.

5. Develop relationships with middlemen

In every situation where contract negotiation becomes more legally challenging, middlemen always appear to bridge the gap between the challenge and small businesses.

Trevor Ewen, COO of QBench, gave a classic example of federal government contracting, which is extremely difficult to do outside the umbrella of one of the existing contractors. Post-AB5, freelancers should develop relationships with middlemen with strong reputations and a presence in California.

6. Build an online presence and keep records

Establishing a strong online presence and explicitly defining your freelance status is one tip for finding new clients, negotiating contracts, and protecting yourself after AB5 as a freelancer. Create a professional website or portfolio to display your talents and previous work. Use social media and freelance platforms to expand your network and display your expertise.

Jessica Shee, Senior Tech Editor and Marketing Content Manager iBoysoft, recommends people become explicit about their freelance status and emphasize independence when negotiating contracts. Clearly stating that you are an independent contractor and not an employee can assist in resolving potential AB5 worker classification issues.

To defend yourself legally, consider consulting with a labor and employment law attorney to review your contracts and ensure compliance with AB5 and other pertinent regulations. Additionally, keep meticulous records of your freelance work, contracts, and invoices to prove, if necessary, that you are an independent contractor.

7. Use clear independent contractor agreements that are easy to understand

Getting a client to sign an independent contractor agreement won't make you an independent contractor by itself. But you should still use written contracts. They might come in handy, especially when the case is closed.

Write up detailed contracts that spell out the scope of the work, the schedule for the project, the payment terms, and the deliverables. Be clear about the connection between you and your client and how independent your work is.

Then, you might want to talk to a lawyer to ensure your contracts align with local labor laws. Talking to an attorney who has expertise in employment law or rules for freelancers can give you peace of mind and help you figure out what to do.

Sai Blackbyrn, CEO of the Coach Foundation, said it is essential to let your clients know that you are a freelancer and what AB5 or other laws mean. Ensure they know you are a self-employed worker, not an employee.

8. Find out what your clients want

If a contractor wants to work independently, the first thing he/she should do is to find out if the business or clients plans to treat them as an employee or terminate the contractor relationship to comply with the law.

9. Collaborate and incorporate for protection

A key tip for freelancers post-AB5 is to diversify your client base and income streams. Instead of heavily relying on a single client, strive to collaborate with multiple clients from various industries. This reduces your reliance on a single income source and the risk of being misclassified as an employee, as having a diverse clientele demonstrates your independence.

Contract negotiations should include explicit language regarding your independent contractor status and scope of work. It is essential to outline the nature of your relationship and your rights as a freelancer, including payment terms, project deadlines, and intellectual property ownership.

Martin Seeley, CEO of Mattress Next Day, suggests considering incorporating or founding a Limited Liability Company (LLC) to separate your personal assets from your freelance business. This may provide added legal protection.

10. Understand worker classification criteria

A significant piece of advice for freelancers operating in the post-AB5 era is to rigorously review and comprehend the guidelines for classifying workers as either independent contractors or employees within their particular state or jurisdiction.

This knowledge will help you navigate client negotiations and contracts more effectively. Ensure your contracts explicitly state your independent contractor status, outlining your autonomy and control over work.

Aviad Faruz, CEO of Know Mastery, elaborated that people must consider consulting with legal counsel or industry associations for guidance on contract language and compliance. Staying well-informed about local regulations and maintaining clear, written agreements will protect your freelance business and help you find new clients while negotiating contracts confidently.

11. See if you are eligible to be in the exemption categories

AB5 is a law, and all laws have a lot of fine print. Getting an exemption is possible, so you should see if you fit into one of these groups.

If you meet one of the exemptions, the next step is to review the particular requirements. Just because you have an exemption doesn't mean you're instantly a freelancer. That means you don't have to take the ABC test. There are less strict rules that your client must follow to show that you’re a contractor.

To be independent workers in California, workers in all exempt groups must pass the control test, which is also known as the Borello test. This test says that you are an employee if the company that hired you can decide what work you do and how it's done. Everyone who worked before AB5 had to take this test.

12. Do what you need to do to pass the ABC test

Try collaborating with your employer to pass the ABC test if you need help to do it. This includes changing your job description and tasks, getting a written contract that says you can choose how and when you do your work, turning your idea into a real business, and advertising your new company. Make a website that says you're available for work and gives potential clients options to offer you work.

To make sure you can also pass the Borello test, you should get a business license, keep a W9 form on file that you send to all new clients automatically, and be able to show that you work with other clients easily. One way to do this is to create a sales page that describes the services you offer or get referrals from current clients. Find one or two current clients ready to act as references and tell them you work for them. One of the things you need to do to get the business-to-business relief from the Borello test is to have other clients.

You need to provide your own tools, vehicles, and workroom. You should spend as much time as possible in a company office if you have to work there. It's up to you, not the company. You choose when to go and how long to stay, not them.

It's time to get more clients if you only work for one company. Being considered an independent worker will be hard if you only work for one company.

13. Don't send more than 35 submissions per client

It might be hard to set up such a limit because you will never know when a client may need your work. Your total income can also be affected by it. But for now, you have to follow this rule.You should assume an approximate number of files planned for each client. Also, keep track of them regularly throughout the year.

Send work to publications with different names owned by the same parent company. You should check each publication separately to know if it maintains the 35-piece limit alone or if the parent company also follows that law.

14. Get help from a lawyer

Getting legal help from legal professionals is always a good idea. This way, you can ask about specifics that apply to your case. Please talk to a lawyer if you want to make sure you're going in the right direction.

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