Note: This blog post serves as an informational overview and not legal advice.
- California’s new law, AB 5, makes it much tougher for companies to classify workers as independent contractors
- Penalties for misclassification include lawsuits, liability for unpaid wages and expenses, civil fines, and action from the state licensing board
- It’s important to review current worker contracts and have a solution in place for ensuring employment law compliance
Assembly Bill (AB) 5 has been signed into law in California
On September 10, the California Senate passed Assembly Bill (AB) 5 and Governor Gavin Newson signed the bill into law on September 18. This bill makes it tougher for California employers to treat workers as independent contractors (ICs).
While this bill was generally targeted at large gig economy companies such as Uber and Lyft, it still applies to all California employers.
Following the passage of AB 5, it is more important than ever to understand the laws that govern whether a worker can be classified as an independent contractor. Worker misclassification “can result in significant costs and wage and hour liability, as well as expenses for employee benefits, unemployment insurance, and workers’ compensation” (Source: JD Supra, LLC). Furthermore, violation of AB 5 leaves you susceptible to civil penalties under Senate Bill (SB) 459.
What does AB 5 change or establish?
For the last 30 years, California courts have addressed employee/independent contractor classification disputes using a test first articulated in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal. 3d 341 (1989) (Source: JD Supra, LLC). This is commonly known as the Borello standard.
Last year, the California Supreme Court, in Dynamex Operations West, Inc. v. Superior Court of Los Angeles (Dynamex), 4 Cal. 5th 903 (2018), rejected the Borello standard for IWC Wage Orders and adopted the “ABC” test which had not previously been applied in California (Source: Holland & Knight LLP).
Basically, AB 5 codifies the strict Dynamex “ABC” test for IC classification. AB 5 expands the reach of the “ABC” test from beyond just Wage Order violations to Labor Code violations, California unemployment insurance, and workers’ compensation proceedings (Source: Holland & Knight LLP). Under the new law, more workers will have to be classified as employees than under the prior law.
What is the ABC test?
Under the “ABC” test, a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates that all of the following conditions are satisfied:
A. The person 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.
B. The person performs work that is outside the usual course of the hiring entity’s business.
C. The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
All three prongs of the ABC test must be satisfied for workers to be classified as independent contractors (Source: Nolo).
What happens if a worker does not pass the ABC test?
If a worker does not pass the ABC test, they must be classified as an employee and are covered by wage orders issued by the California Department of Industrial Relations, Industrial Welfare Commission. Wage orders include:
- Payment of minimum wage
- Provide a minimum amount of annual paid sick leave
- Pay employees time-and-a-half for overtime over eight hours per day or 40 hours per week (but administrative, executive, or professional employees are exempt)
- Reimburse employees for out-of-pocket expenses necessarily incurred on the job, such as driving expenses
- Provide meal and rest breaks
- Pay employees for unused vacation time when employment ends, and
- Comply with California paycheck rules.
Links to all California wage orders can be found here Industrial Welfare Commission.
Additionally, companies must provide employees with California unemployment insurance and adhere to the California paid family leave program.
Furthermore, companies with at least one employee are required by California law to have workers’ compensation insurance (Source: California DIR).
Are there exemptions from the ABC test for construction companies?
AB 5 does provide some exemptions for certain professions / job categories from the ABC test for determining IC status eligibility. As noted in the excerpt below, the ABC test does not apply to the relationship between a contractor and subcontractor in the construction industry if certain conditions are satisfied.
According to AB 5, “these exempt occupations would include, among others, licensed insurance agents, certain licensed health care professionals, registered securities broker-dealers or investment advisers, direct sales salespersons, real estate licensees, commercial fishermen, workers providing licensed barber or cosmetology services, and others performing work under a contract for professional services, with another business entity, or pursuant to a subcontract in the construction industry.”
The stated exempt occupations are not automatically exempt from AB 5. Rather, “an individual whose work meets the exemptions means that the ABC test does not apply, but the hiring party must still be able to demonstrate that contractor status is appropriate under Borello and/or by other statutory provisions as specified in the bill” (Source: Holland & Knight LLP).
For the construction industry, these statutory provisions are:
A. The subcontract is in writing
B. The subcontractor is licensed by the Contractors State License Board and the work is within the scope of that license (except for certain subcontractors providing construction trucking services)
C. If the subcontractor is domiciled in a jurisdiction that requires the subcontractor to have a business license or business tax registration, the subcontractor has the required business license or business tax registration
D. The subcontractor maintains a business location that is separate from the business or work location of the contractor
E. The subcontractor has the authority to hire and to fire other persons to provide or to assist in providing the services
F. The subcontractor assumes financial responsibility for errors or omissions in labor or services as evidenced by insurance, legally authorized indemnity obligations, performance bonds, or warranties relating to the labor or services being provided
G. The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed
If all of the criteria are not satisfied, the worker would be held to the ABC test for determining independent contractor eligibility or determined to be an employee since the arrangement between the hiring party and the worker does not meet the criteria set forth for independent contractor status in the construction industry for the state of California.
For further information, see this question and answer document from the California Department of Industrial Relations on determining independent contractor status.
Determining whether a worker should be classified as an independent contractor or employee
It is up to companies to determine whether workers that are currently hired as independent contractors should be reclassified under the new law. Additionally, companies should also consider the new law when hiring new workers.
According to the New York TImes, “workers are likely to be employees if the company directs their tasks and the work is part of the company’s main business.”
The United Brotherhood of Carpenters recently estimated that they are 300,000 construction industry workers currently misclassified as independent contractors in the United States, resulting in around $2.6 billion of unpaid taxes each year (Source: Construction Dive).
The United Brotherhood of Carpenters recently estimated that they are 300,000 construction industry workers currently misclassified as independent contractors in the United States, resulting in around $2.6 billion of unpaid taxes each year
As mentioned previously, worker misclassification can result in a hiring firm having to pay fines, penalties, and back pay and benefits (Source: Nolo).
What are the penalties for misclassifying a worker as an independent contractor?
Summary of potential penalties:
- Lawsuits from California attorney general and city attorneys
- Lawsuits from workers, including class actions
- Liability for unpaid wages, including unpaid overtime
- Liability for unpaid expenses for employee benefits, unemployment insurance, and workers’ compensation
- Civil penalties up to $25,000 per violation
- Action by the Contractors’ State License Board
- Public posting of your violation
According to Karen Tynan, an attorney with Ogletree Deakins in Sacramento, misclassifying a worker can result in “incredibly stiff penalties and liabilities.”
Furthermore, Dan Langford, executive secretary-treasurer at the Southwest Regional Council of Carpenters, stated that, “AB5 will crack down on worker misclassification, which is rampant in the construction industry and violates fundamental rights like minimum wage and sick leave” (Source: Construction Dive).
As a company, your decision to classify a worker as an IC is subject to review by the California Labor Commissioner, the Employment Development Department, the Franchise Tax Board, and other agencies, usually on a case-by-case basis.
AB5 empowers the California attorney general, city attorneys in large cities, and local prosecutors to sue hiring firms for misclassifying workers. Individual workers can bring their own lawsuits, including class actions on behalf of large numbers of similarly situated workers.
Workers who do not receive minimum wages, overtime pay, or pay for meals and breaks because their employer misclassifies them as an independent contractor can file a wage claim with the Division of Labor Standards Enforcement (the Labor Commissioner’s Office).
In addition to fines from Labor Code violations, SB 459 also makes employers liable for civil penalties of $5,000 to $15,000 for each violation of “willful misclassification” of employees as independent contractors (Source: California Employment Law Report). Repeat offenders of worker misclassification can see their civil penalties increase to a minimum of $10,000 to $25,000 per violation.
Repeat offenders of worker misclassification can see their civil penalties increase to a minimum of $10,000 to $25,000 per violation.
Furthermore, California agencies that find companies in violation of AB 5 are required, under SB 459, “to notify the Contractors’ State License Board of a violator that is a licensed contractor, and require the board to initiate an action against the licensee.”
Employers who violate the law are also required to post a notice on their website, or if the employer does not have a website, they must post it in an area available to employees and the general public, for one year about the violation. (Source: California Employment Law Report)
What is “willful misclassification”?
To be clear, according to Senate Bill 459, “Willful misclassification” means avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor.
How to respond to AB 5
With the significant penalties possible under the new law, it’s important to have an understanding of the ramifications of misclassifying workers as ICs.
You should review all existing arrangements with existing ICs to ensure compliance and bear AB5 in mind when making future hiring decisions.
According to Todd Wulffson, Managing Partner at Carothers DiSante & Freudenberger LLP, construction business “can no longer rely on simply “staying off the radar” of entities whose sole purpose is to find that all independent contractors are really employees.”
Todd recommends that construction companies, “retain the services of a competent human resources professional or office manager to ensure compliance.”
Todd goes on to provide more helpful tips, including to “pay independent contractors through accounts payable, based on invoices received, and never out of payroll” (Source: Construction Executive).
Again, if a worker should be classified as an employee, the employing firm “will be required to make the appropriate payroll tax contributions and deductions for these workers, carry workers’ compensation insurance, pay minimum wage, provide overtime and meal and rest breaks for non-exempt workers, respect anti-discrimination laws, and provide mandated job-protected leave” (Source: Mizrahi Law).
Workyard as a solution: Remain compliant and grow your business
- Employment law compliance
- W-2 onboarding and terminations
- Time tracking and automated payroll
- Overtime pay regulations
- Top-notch, pay-as-you-go insurance coverage
- Dedicated HR representative
Employment law compliance
Workyard helps construction companies of all sizes remain compliant under federal and state employment laws.
W-2 onboarding and terminations
We ensure employees are properly documented as W-2 employees and have the appropriate right to work documentation on file.
Time tracking and automated payroll
For time tracking and payroll, clients utilize our Crew app which ensures workers are properly compensated for their hours worked, whether it was regular time, overtime, or double time. The app is easy to use for the workers and time approvers, which helps to reduce administrative overhead and timesheet errors.
Worker hours are fed directly into our payroll processing system which ensures your workers are paid on time, every time. Furthermore, we handle payroll tax filing (FUTA, SUTA, FICA, etc). All you have to worry about is paying us a single invoice each week.
Top-notch, pay-as-you-go insurance coverage
Workyard provides workers’ compensation, non-owned auto, general liability, and employment practices liability insurance. This ensures your workers are covered in case of accident and/or injury and your business is protected against fines for not carrying the proper insurances.
Dedicated HR representative
Overall, Workyard lets you focus on running and growing your business while we take care of all the HR admin and compliance work. Whenever they need it, our customers have access to a dedicated HR representative who is available to answer questions.
AB 5 may pose some challenges for the construction industry, but with the Workyard, you can be sure your business is in good standing and protected against employment litigation.
If you’re interested in learning more about how Workyard can help your business, you can fill out the form on this page.