Classification of workers as employees vs independent contractors in light of CA Bill AB5
Updated: May 19, 2020
The issue of classifying a worker as an employee vs an independent contractor is obviously not new and dates back to at least early 1990s when the IRS started cracking down on improper classification and collecting billions of Social Security back taxes. Yet, the issue appears to be as controversial today as it was almost thirty years ago, and it continues being litigated in courts.
In the current gig economy, with remote and flexible work arrangements becoming more common, the classification boundaries have become even blurrier. Although some workers may prefer retaining their independent status, many wish to be classified as employees since independent contractors lack certain protections, cannot join unions, are not entitled to minimum wage or overtime (unlike nonexempt employees; exempt employees are not entitled to overtime either), and are not covered by health insurance and by unemployment benefits.
Courts often refer to the following seven-factor test to determine classification of a worker:
1. Degree of control. The right to control is regarded by the courts as the most crucial factor. Ability to set own hours and work location, manners and methods employed in performing a job, servicing other customers, receiving supervision and/or direction, and trainings are among several factors used in assessing the degree of control. It is important to note that the actual exercise of control is not important here, it is the right to control that is crucial in this determination. Therefore, the answer is often far from being black and white.
2. Which party invests in work facilities used by a worker. Does the worker own equipment or does he/she use employer’s?
3. The worker’s opportunity for profit or risk of loss. Is there a set compensation? Will the worker be responsible for any damages? Does the worker get paid for his/her time or only upon achieving a set outcome?
4. Right to discharge. Is a cause to fire needed? Strong evidence in support of an employment relationship is the right to discharge at will, without cause.
5. Integral part of regular business. Does success or continuation of business operations depend on the performance of services by the worker? The more integral to the business worker’s services are, the more likely the worker will be treated as an employee.
6. Permanency of relationship. The longer the relationship, the higher the likelihood of being classified as an employee.
7. Relationship the parties thought they created. The intent of the parties to create specific relationship is reviewed and substance over the form prevails.
The recent California Bill AB5 signed into the law on September 18, 2019 establishes a three-factor test for proper classification of employees vs independent contractors. According to the provisions of AB5, in order for the worker to be classified as an independent contractor, the following three conditions are to be met:
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.
3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Thus, California has established much stricter framework for determining the proper classification of workers and left very little wiggle room for interpretation. The above three-factor test does not apply to the following occupations and instead the determination of employee or independent contractor status for individuals in those occupations shall be governed by the California Supreme Court’s decision in S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341:
1. A physician and surgeon, dentist, podiatrist, psychologist, or veterinarian licensed by the State of California;
2. An individual who holds an active license from the State of California and is practicing one of the following recognized professions: lawyer, architect, engineer, private investigator, or accountant.
3. A securities broker-dealer or investment adviser or their agents and representatives that are registered with the Securities and Exchange Commission or the Financial Industry Regulatory Authority or licensed by the State of California;
4. A direct sales salesperson as described in Section 650 of the Unemployment Insurance Code, so long as the conditions for exclusion from employment under that section are met.
5. A commercial fisherman working on an American vessel.
6. A person or organization who is licensed by the Department of Insurance.
In S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989), the California Supreme Court reviewed the case of sharefarmers being eligible for worker’s compensation and came to somewhat surprising conclusion in the circumstances that despite multiple factors favoring independent contractor classification, the sharefarmers were to be treated as employees.
The issue remains contentious and application of the above factors may not be as straightforward in many circumstances. However, since misclassifying employees can be a costly mistake for a business, caution must be taken in evaluating and documenting final classification.