October 15, 2020Compliance

AB5’s ABC test explained

At the center of California’s AB5 law, also known as the ‘gig worker law,’ is worker classification. The law aims to define who is an employee and who is an independent contractor in California. Worker classification under AB5 is done via the application of the ABC test, a three-part legal test used to determine if a worker should be classified as an independent contractor.

Distinguishing between employees and independent contractors is important for payroll and many other critical business and financial functions. Under AB5, workers in California are assumed to be employees who are eligible for benefits like overtime pay, breaks, the right to minimum wage, healthcare, retirement, unemployment insurance and more, while independent contractors are not. 

Read more about California’s gig worker law by visiting our posts What is AB5? and Who is exempt from AB5? 

Is my business compliant with AB5?

For California-based businesses and companies with significant business in California, leaders, finance and HR professionals are left wondering if they are compliant with the many nuances of this new law. Exemptions aside, AB5 compliance is determined via the application of the ABC test. California employs several legal tests to determine whether a worker should be classified as an employee or independent contractor, but the ABC test is specifically used to address AB5 compliance. 

Under AB5, the default assumption is that a worker in California is an employee. To classify a worker as an independent contractor, employers must apply the ABC test and determine that all 3 qualifications found in the test are present. Compliance with AB5 is initially self-determined; employers are responsible for the correct classification of workers as employers or independent contractors. If you classify incorrectly, you may face legal repercussions and fines. When in doubt, contact legal counsel to ensure you’re in compliance. 

What is the ABC test?

The ABC test comes from the Dynamex decision, which was a landmark case in the California Supreme Court in 2018. In this case, the state of California established a new standard for determining employee status (using the ABC test over the existing Borello test), and embraced the assumption that all workers in California were to be classified as employees.

The ABC test determines if a worker should overcome this default classification and instead operate as an independent contractor. The determination is done in three parts—thus the A-B-C title—and if any part of the criteria is not met, then the worker is an employee. 

Under AB5, a worker may be classified as an independent contractor only if they meet all of the following criteria in the ABC test: 

A: The worker is free from the control and direction of the hiring entity in connection with the work’s performance, both under the contract for the performance of the work and in fact.

B: The worker performs work that is outside the usual course of the hiring entity’s business.

C: The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

How are independent contractors free from control? 

In the first part of the ABC test, workers must be “free from control” from the employing party. This means that both in the contract and in the reality of the work environment, the employer does not exert control over the worker. The IRS provides further guidance in defining “control” in behavioral, financial and relationship aspects. 

Behavioral control is viewed as prescribing how, where or when the work should be done. Financial control is having the ability to control economic aspects of the worker’s job such as providing investment in critical equipment, reimbursing expenses or restricting the ability for the worker to perform services elsewhere. Finally, relationship control is manifested in how the parties interact. Contracts, statement of works and other documentation can clarify that the relationship between worker and employer are independent.

How is the work of an independent contractor determined to be outside the usual course of the hiring entity’s business?

In the second part of the ABC test, it must be proven that a worker is performing work “outside the usual course of the hiring entity’s business.” This means that the services and tasks the worker is performing in the fulfillment of their contract cannot be the same work that the hiring party is performing for its own customers. 

For example, if a company provides pool cleaning to the market, they cannot hire a worker to perform pool cleaning and classify them as an independent contractor. However, a hotel or hospitality company may hire a pool cleaner as an independent contractor to service pools on property it owns and provides to its customers. 

On the other hand, truck drivers (who mostly work as owner operators for motor carrier companies) are usually performing work within the usual scope of business for a trucking company. Therefore, classification as an independent contractor for truck drivers is not possible under AB5.

Determining if work is outside the scope of the hiring party’s work requires reviewing all the services and tasks the company performs in order to ensure the law wouldn’t interpret overlap between its usual course of work and the work being performed by an independent contractor. 

What is an independently established trade, occupation or business?

Finally, the third factor of the ABC test is establishing that the worker essentially has their own established occupation and is performing work via their independent business or trade. This does not mean a worker must establish their own business entity like an LLC. This generally means that a worker is able to deliver services or tasks on a per job basis, delivered to the open market independently of any hiring entity or employer. 

In ABC, we trust  

It’s no secret that AB5 has seen a lot of scrutiny, criticism and change. Even though the law only went into effect in January 2020, California legislators have introduced multiple amendments and exemptions to the law. And there continue to be ongoing fights in the courts with well-known gig economy companies like Uber and Lyft. 

It’s likely that AB5, its reach and its exemptions will change further. Most recently, Proposition 22 shielded transportation and delivery drivers from AB5. However, the core of the AB5 law has not and is unlikely to change (unless the entire law is repealed). At the heart of AB5 is how companies classify workers, and that classification comes via application of the ABC test. As an employer, if you cannot unequivocally determine that all 3 factors of the ABC test are met by your workers, you must classify workers as employees in order to stay compliant with this complex, but established law. 

Disclosure: The contents of this post should not be viewed as legal advice.