ABCs of AB5
Written by Aquent. Last updated 1/30/2020
Estimated read time: 10 minutes
- California’s AB5 legislation regulates how workers are classified in the gig economy and beyond. Although it’s a California law, it has ramifications across the United States.
- For most jobs and professions, classification is based on the 3-pronged ABC test. If a company can prove that all three criteria are satisfied, a worker can be considered an independent contractor (1099). Otherwise, the worker must be classified as an employee (W-2).
- This Guide will help you understand how workers are classified under the law and gauge if your company is at risk.
- There are simple solutions to help you become compliant without making drastic changes to your business.
What is AB5?
As the home to technology, entertainment, and many other industries, California has spearheaded Assembly Bill 5 (AB5), a law that narrows the criteria for classifying independent contractors. The intent of AB5 is to prevent companies from incorrectly classifying gig workers and freelancers as contractors instead of employees, to avoid providing benefits, fair wages, and worker protections.
Prior to AB5, workers were classified as independent contractors if they met the majority of the criteria in the Borello test. AB5 relies on the stricter ABC test. This three-pronged test requires that workers be free from the control of the hiring company, that they do work outside the usual business of the hiring company, and operate as an independent business in order to be considered contractors.
While the ‘how’ of AB5 is still unclear, California has made enforcement—and the penalties for non-compliance—a priority. Companies that do not comply (i.e. are found to be intentionally misclassifying their workers) could face state civil fines up to $25,000 per violation, remuneration of back pay (overtime and paid time off), potential loss of valuable workers, and damage to their reputations.
Although AB5 only applies to California, there are already signs that other states will follow suit. New York and New Jersey are working on similar laws that could take effect in the next couple of years. While you may think you don’t need to worry about AB5 and its implications right now, you likely will in the near future.
The objective of AB5 is simple, but its application can be complex and difficult to understand. In the next sections, we will describe the ABC test in detail and provide examples to illustrate how workers are classified under the new law.
How does AB5 classify workers as employees or independent contractors?
AB5 is built upon a landmark California Supreme Court case which crystalized the differences between independent contractors and employees. The current version of the law states that employers must use the ABC test to prove that a worker is, in fact, an independent contractor.
What is the ABC test? It is a set of three conditions that must all be satisfied in order to define someone as an independent contractor.
THIS IS THE ABC TEST:
Let’s walk through these three key criteria and provide examples to help clarify how the law is applied. We will use two hypothetical business scenarios:
- Newbury, a marketing company, hires Rosemary, owner of Noms Catering, to cater an event.
- An ice cream delivery app, Scoops, hires local cyclists to deliver ice cream.
Condition A: Is the worker free from the control and direction of the hiring company while doing the work?
The A in the ABC test is focused on understanding the nature of the relationship between the business and the worker. Condition A looks at how much freedom a worker has and how much control a business exerts in when, where, and how the work is completed.
Here are some examples of questions that determine the nature of a worker-business relationship:
Does the worker set their own hours?
- Newbury, the marketing company, would not set the hours for the caterer Rosemary to prepare the food for the event.
- The cyclists’ delivery schedules are defined by Scoops.
Can the worker choose where to perform the work?
- Rosemary is able to choose which kitchen she will use to prepare the food.
- Scoops tells the cyclists where they are allowed to deliver and where they are not.
Can the worker perform similar services for other clients?
- Rosemary is able to take on other catering clients in addition to Newbury.
- Cyclists for Scoops can perform delivery services for other apps, as long as they don’t interfere with their Scoops deliveries.
Does this worker have a Statement of Work that governs payment and deliverables?
- Rosemary/Noms provided Newbury with a contract that lays out the deliverables, personnel, and agreed upon delivery date and time for the catering.
- The cyclists cannot provide a statement of work. They simply agree to the request from the Scoops app to deliver ice cream.
Is the worker exempt from any training?
- Rosemary is not provided any training from Newbury.
- Cyclists could require training from Scoops on how to interact with customers and how to log their deliveries in the app.
Condition B: Does the worker perform work that is outside of the hiring company’s usual business?
While condition A focuses on how a worker performs work for a business, condition B is concerned with the nature of the work being performed. The crux of the question is whether the work is essential to or part of the usual business of the hiring company. This concept is clarified further by understanding whether the hirer has employed workers in a W-2 status to perform similar work in the last year. If they have, the work appears more essential to the business.
Here are some questions that can help clarify the meaning of this condition:
Is the work performed by the contractor non-essential to the employer’s business?
- Catering is non-essential and not part of the usual business of Newbury’s marketing operations.
- The cyclists’ deliveries are essential to the Scoops business because it is a local ice cream delivery service.
Does the business employ W-2 employees to perform similar work, currently or in the last 12 months?
- Newbury has not had any caterers as W-2 employees in the last year (or ever).
- At the beginning of the year, Scoops employed a W-2 delivery person while it built up its pool of delivery workers.
Condition C: Is the worker customarily engaged in an independently established business, trade, or occupation that performs similar work to that provided to the hiring company?
The last condition in the ABC test focuses on whether the worker can credibly demonstrate that they have an established independent business, which is separate from the business hiring them for a specific project or task.
Several questions can help to clarify the intent of this part of the test:
Has the worker provided similar services to other clients in the last 12 months?
- Rosemary has provided similar catering services to other clients in the last year.
- Cyclists for Scoops could perform similar delivery services for other apps but typically only work for Scoops.
Does the worker have insurance (workers' compensation, general liability, etc.)?
- Rosemary is the owner of Noms LLC and has obtained workers’ compensation, general liability insurance, and other insurances that are separate from the policies held by Newbury.
- Scoops cyclists are not business owners and do not obtain workers’ compensation or liability insurance for their delivery services. Scoops does have an LLC along with liability insurance and other benefits that protect its product managers, developers, and others.
Does the worker use their own equipment to perform the tasks for which they are hired?
- Noms Catering has a kitchen, specialized equipment, and space it uses to cook for the Newbury event.
- Cyclists for Scoops are able to use their own bikes or they can rent a Scoops-branded bike from Scoops for a monthly fee.
ABC Test Results: Noms and Scoops
Under AB5, Rosemary, owner of Noms Catering, is an independent contractor to Newbury marketing because she satisfies all the criteria in the ABC test. In contrast, the cyclists for Scoops are not independent contractors because they cannot satisfy all the criteria laid out in the ABC test. Scoops would need to make the cyclists their W-2 employees in order to continue using them for deliveries in California.
Professional Services Exemptions from the ABC Test
While the ABC test is the primary determinant of whether a worker is an independent contractor, there are exemptions to this test under the law. Some professionals like lawyers, architects, and physicians, are subject to another set of criteria called the Borello test. Borello is a set of 13 criteria that help to determine independent contractor status. Unlike the ABC test, which requires all elements to be satisfied, the professions subject to the Borello test do not need to satisfy all 13 criteria. These criteria help determine if the worker is under the control and direction of the hiring business.
When it comes to certain professional services providers such as marketers, graphic designers, writers, and photographers, there is a potential exception to the ABC test. The law outlines six criteria that must first be met in order to use the Borello test instead of the ABC test. These criteria aim to establish that the worker is part of a business that is properly licensed, insured and wholly different than the hiring business. They are:
- Does the worker keep a business location that is separate from the hiring firm? (this can include the worker’s residence)
- Does the worker have a business license as well as any necessary professional licenses or permits?
- Is the worker able to negotiate their own hourly rates for the services performed for the hiring business?
- Is the worker free to set his/her own hours?
- Is the worker performing similar contracted work with other businesses or remaining available for other potential hirers to perform similar work?
- Does the worker use their professional, independent judgment and discretion while completing their work?
When you know your AB5 risk, you can address it.
AB5 and its application is highly nuanced. In order to avoid improper worker classification, it is important to understand the ins and outs of the law. When does the ABC test apply, when do you use other criteria, and when are workers exempt from AB5 altogether? And what do you do if you find that your workers no longer qualify as independent contractors?
The good news is there are options that help companies easily comply with AB5. These allow you to maintain the flexibility of working with freelancers, retain any existing talent you use, and provide them the employee status, pay, and benefits they deserve under the law. You simply have to find the right solution.
Disclaimer: The materials available on this web site are for informational purposes only and not for the purpose of providing legal advice or opinions. You should contact your attorney for advice and guidance with respect to any particular issue, problem or question.