Independent Contractor or Employee? Guidelines to Classifying Workers After California’s AB-5

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“I want to hire a worker for a couple of months and I was wondering if I could bring them on as an independent contractor? Please let me know if this is ok.”

“I want to hire a worker for a couple of months and I was wondering if I could bring them on as an independent contractor? Please let me know if this is ok.”

Our advisory team at Zenefits receives a variation of this question from clients on a weekly basis. So a large part of our job is helping employers understand that many factors determine how a worker is classified. Unfortunately, it’s not as straightforward as it might seem. Employers don’t have the freedom to simply label a worker as a contractor because the work isn’t considered long-term. Instead, there are federal — and in the instance of California’s new law — state requirements that need to be met in order for a worker to qualify as an independent contractor.

This article will broadly review the federal requirements as well as the new California AB-5 law to help employers understand their obligations when classifying workers.

On the federal level, the IRS sets basic guidelines that employers can review when determining whether or not their worker should be considered an independent contractor. The IRS wants employers to determine and define their relationship with this new worker to see if they in fact qualify to be an independent contractor.

Broad federal guidelines for employers

Below are guidelines provided by the IRS. They are not a strict checklist employers can easily mark off, but instead offer a broad understanding of what the IRS considers important in determining an employee and employer relationship.

  • Behavioral control:  A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised.
  • Financial control: Does the business have a right to direct or control the financial and business aspects of the worker’s job?
  • Relationship: The type of relationship depends on how the worker and business perceive their interaction with one another.

While the IRS provides further interpretation and guidance as to these categories on their website, you can see that the federal government has set a blurry line that employers may find difficult to navigate.

The California “ABC” contractor test

Last year, the California Supreme Court implemented a more definitive system to help employers in the state understand what type of worker qualifies as a contractor. The test they established is referred to as the ABC contractor test because it sets three criteria that must be met in order for an employer to legally categorize a worker as a contractor. A worker is presumed to be an employee unless they can meet these criteria.

  1. The worker 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 worker performs work that is outside the usual course of the hiring entity’s business; and
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Based on these requirements, certain California workers may no longer qualify as contractors even if they previously qualified as such under the IRS criteria. For more information on the ABC test, please review the article our team created last year “What you need to know about California’s new ABC Contractor law” when this test was introduced.

Companies may be wondering if this is the ABC test, then what is AB-5? Well this September, the governor signed AB-5, a California bill, that incorporates the ABC test into statutory law. The main thing to note with this change is the same requirements that went into effect last year are still in place. This law does not change those requirements and instead codifies the decision the California Supreme Court made in 2018. This means that if your company was already complying with the ABC test then you will just need to keep following the guidelines set forth by this test when hiring contractors.

What are the penalties for noncompliance?

If your company has work locations in additional states, we recommend reviewing state and local agencies for regulations that may apply to your workers. Our Advisory Team can assist with this process by reviewing any relevant regulations with your company if you are signed up for Advisory Services. We also suggest that employers consult their legal counsel to avoid the hefty penalties that may attach to workers misclassified as independent contractors. In California alone, these penalties can range from $5,000 – $25,000 per violation.

If you have determined that your worker is an independent contractor, the next step is getting them set up with your company. At Zenefits, we know it’s important for employers to have the ability to distinguish between classifications within their workforce, especially with new laws popping up on the state level. This is why we allow employers to clearly label their workers as employees or independent contractors during the hiring process. In addition, employers have the ability to send out personalized contracts, choose a payment method, determine the length of the contract, generate W-9 forms and log hours. Our goal is to help employers hire their workers based on the needs of their business, whatever those may be.

Classifying workers can be a complicated process. New laws, like AB-5, can redefine how companies classify independent contractors. It is important that these workers be classified correctly and we recommend consulting your legal team during this process. If your company already uses Zenefits, then we can provide the needed resources to help you set them up in our system.

If you have additional questions regarding worker classifications, then we recommend touching base with your HR department and reaching out to your legal counsel.

 

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