California’s AB-5 Bill Highlights Impact of Misclassifying Workers

September 17, 2019
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Author: Stephanie Ludwigsen

California set a precedent by passing Assembly Bill 5 (AB-5) which will reclassify up to two million independent workers in California. AB-5 will give these workers access to benefits including minimum wage earnings, overtime pay, health insurance and rights to organize.

Governor Newsom states that the law helps to mitigate “workers being classified as independent contractors, rather than employees, which erodes basic worker protections.”

Even if you do not have business offices in California, every Human Resource (HR) manager and business owner should take heed of this development.

California AB-5 Will Impact Thousands of Businesses and Millions of Gig Workers

What is AB-5? and What is ABC?

First, what is AB-5? The short version is that the California Supreme Court ruled against Dynamex Operations West, Inc for a cost-saving measure it made 15 years ago. Dynamex is a same-day courier and delivery service for businesses and direct consumer deliveries. Prior to 2004, Dynamex classified its California drivers as employees. Starting in 2004, Dynamex switched all of its drivers to independent contractors as a cost-saving measure.

AB-5 makes the decision against Dynamex a much bigger and broader deal. Assembly Bill 5 stipulates that misclassifying workers as independent contractors denies basic rights and protections deserved under the law. The state of California lays out penalties, both financial and criminal, for businesses that do not comply in classifying workers correctly.

So, what is ABC? ABC is the method by which companies determine whether they have an independent worker or an employee. And if you think this ABC test only applies to California companies, don’t check out just yet. New Jersey and Massachusetts are also enforcing the ABC test, and other states are using it in a variety of specific employment situations.

The ABC test asks that three facets of employment be met. To be an independent contractor, an employer must prove that the person is:

  • free from company control;
  • performing work not central to the company’s business; and
  • has an independent business in their industry

In short, if you fail one of the three criteria, get the welcome basket ready because you have an employee. Where companies will likely get into trouble is under the “performing work NOT central to the company’s business.” Strangely enough, Uber insists its 200,000+ California drivers are not instrumental to its business, and as such, will not be reclassifying them. Most other businesses will not likely have the same resources to enter into litigation on the matter.

The Consequences

Misclassifying an employee comes with a host of penalties. Tax penalties, fines, back wages and jail time are all possible penalties, depending on the state(s) where you operate. Fines could range from a few thousand to several hundred thousand dollars.

This is where small businesses are impacted the most. The convenience of independent workers is an attractive option for many early-stage businesses. This is one of those times when an HR director or HR consultant pays for themselves ten times over.

Business owners, particularly in smaller entities, should:

  • Ensure the head of Human Resources or HR consultant understands the state law where the business operates and when/how it may be changing.
  • Know the ABCs. Ask for guidance in particularly challenging cases.
  • Understand the financial impact of turning an independent contractor into an employee. It may be less costly in the long run.
  • Understand that gig work is a trending topic. Contract workers that work within the organization may be seeing news stories that impact them. Be prepared to engage in these conversations.

What’s Next?

In California, companies have until January 1, 2020, to comply. Whether the law will be retroactive is yet to be determined. Employers will need to quickly lean on HR teams to clarify any nuances to the law and the impact of worker transitions.

For other states, when it comes to legislation, California is oftentimes the blueprint. Business owners with a high percentage of independent workers would be well-served to discuss how their business will be impacted if a similar law went into effect.

“People ought to be very concerned because what happens here does tend to get copied in other states,” said Joseph Rajkovacz, Director of Governmental Affairs and Communications for the Western States Trucking Association.