What You Need to Know About AB5 (CA's new law about employee relationships)
Before we even start – Please know that this general information, not legal or tax advice. You need to consult your own financial & legal teams to make sure that you are in compliance with this – and please make it a priority, the penalties are intense! As with any new legislation, it will work its way through the courts a few times and decisions will refine parts of the law or provide exemptions to portions that are unclear right now, so there may be future edits to our opinion on how to handle it. This is how we have interpreted the law to be applied to our clients with the information we have available at this point.
Also, please note that we are interpreting this through the lens of the clients that we work with, specifically coaches, course creators, agency service providers + digital entrepreneurs. There are pages of code that you can read through here, if you are having trouble sleeping, give this a try https://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201920200AB5 if you want to research how it will impact your own business.
This new legislation, California Assembly Bill 5 (AB5) was signed into law late 2019, taking effect for 2020. Basically what CA is trying to do is say that anyone that you pay money to in your business is an employee, unless you can show that they fit one of the specific exclusions. The burden of proof is on you, the business, to prove that someone you pay fits the definition to be classified as a subcontractor/vendor and not an employee.
This isn’t new, there have always been rules to follow with this from the IRS and the State Departments of Labor, but CA AB5 takes things to a new level. But, stick with me to the end, we will show you how to easily take action on making sure you are compliant today.
WHO DOES THIS IMPACT?
- If you are a business located in CA, with team located in CA
- If you are hiring subcontractors or vendors who are located in CA (even if your business is located outside of CA
Easy way to remember, this is a rule to (allegedly) protect the workers, so it follows where the workers live, not necessarily where your business is located.
So, if you aren’t located in CA or don’t have anyone on your team who is located in CA, you don’t need to worry about this right now. But, I wouldn’t be surprised to see more states adopting similar legislation in the future as the gig economy continues to grow, so it’s probably a good idea to be familiar with this and start to put the proper protections in place for your business too. New York and New Jersey are already in talks about similar laws.
When you have someone working with you in your business, they are either an employee (you have them in a payroll system you are withholding taxes, paying worker’s comp, complying with employment laws, etc. for them) or they are a vendor/independent contractor (they have their own business, invoice you and you pay them directly without any withholdings).
THE THREE PRONGS TEST
You should apply the Three-Prong Test to anyone in your business to see if they are an employee or an independent contractor. You have to pass all three, or they would be considered an employee.
Control: You don’t control when or how they do their work. This has to be true both in how the contract is written and how you actually work with them.
Type of Work: The work that they are doing is outside of your usual business activities.
Other Clients: The worker is also providing these services to other businesses, not just yours. Obviously, you can’t control if someone just doesn’t land other business, but they should be actively trying to build their business, have a website, doing marketing, etc.
Let’s look at a few example situations:
Let’s say you hire a cousin/friend/family member to be your virtual assistant. She works from home, but is required to come to your team meetings each week, you pay her hourly and she follows the workflows that you have set up in your business – it would be likely found that she is an employee. Alternatively, if you hire a company that provides Virtual Assistance support, you pay them a monthly retainer and they bring their expertise into the role, they design systems with you and enhance your business. And they do this for others as well. See the difference? I am not saying that you would definitely win if contested, or that you can’t have standing meetings with your team, but you can clearly see the difference between the two situations.
If you are an accounting firm who hires a web designer, which is outside of the services that the company provides, vs an accounting firm who hires a freelance bookkeeper to provide bookkeeping services as part of their work with their clients. If this bookkeeper is fed work by the firm, paid hourly and has to report in to their manager, again – likely an employee.
THE 7 EXEMPTIONS
The law provides for 7 exemptions to the three-prong test, and you can go read the full list in the bill, but the one that will impact our clients is “a bona fide business to business contracting relationship” or essentially – when a business hires another business.
Like in the example above – if your company contracts with another business who provides VA services to you, this helps to establish that they are a contractor, not an employee. Be sure that your agreement with them is with your company hiring their company (which it should anyway) but to prove this it’s even more important.
So, is the answer to only hire other businesses? Sort Of. (Don’t you love it when accountants and lawyers answer maybe?)
One of the differences with AB5 versus the Federal and previous state tests is that just because it’s a business to business relationship doesn’t necessarily mean you are in the clear. Like in the VA example above, just having your cousin form an LLC and still just work for you under your control, bill you hourly, attend your team meetings and be micromanaged by you – it’s possible she could still be found to be an employee. So when I say to hire another business, I don’t mean just make your ‘should be employees’ form an LLC, but that you should actually hire other businesses.
Your team will need to speak to their own advisors in terms of what type of business they should create and what the fees will be for doing that, but if it truly is a business to business relationship it’s a great way to give you another reason to be exempt from AB5.
For a super-easy way to create an LLC, refer your team to Amanda at CorpNet (ABeren at corpnet dot com), they are our go-to experts for all things corporate structure & compliance. She will let them know about all of the options available and the applicable costs. And – tell them that Empowered Profit sent you and they will give you their VIP service at a discounted rate.
WHAT YOU SHOULD DO TODAY:
- Make a list of all of your team members. Review the list to see if any of them are based in CA.
- For all of the CA impacted workers, review your relationship with them. Are they a business relationship, or do you feel they could fall under the employee category based on the info above?
- Keep notes on each team member so you can prove later if questioned why you believe them to be exempt and able to be paid as a contractor.
- Decide how you want to structure your relationship with them in the future:
- Hire them an employees
- Have them create an LLC/Corp (as long as they really are a business)
- Work with an attorney who can review your business and its structure and give you some personalized recommendations on how to make sure you are compliant.
Need help? We are here for you. We can help you figure out the transition plan to take them from contractor to employee, including what you should pay them, how to structure the relationship, the impact it will have on your company profit, get your payroll all set up, and more.