California’s Assembly Bill 5 (AB5) is one of the least understood pieces of legislation to hit the state of California in years. Many are wondering: What is AB5? Who is exempt from AB5? And will those exemptions change? Because it’s brand new, there is little in the way of history to help with interpreting the nuances of the law. Many companies have been trying to understand the implications of AB5, so they can ensure they are in compliance.
With AB5 taking center stage for many gig, marketplace and peer-to-peer businesses, it’s important to know whether or not a certain occupation, profession or job is exempt from the law. Under AB5, California workers are presumed to be employees unless they pass the ABC test. Since the employer must make the determination about whether to classify a worker as a contractor or employee—and incur potential liability for making the wrong decision—they need to get it right. When in doubt, contact an attorney.
What jobs are exempt from AB5?
AB5 uses the ABC test to determine if a worker is an employee or independent contractor. Under the ABC test, a worker is presumed to be an employee unless the worker:
A. Is free from the control and direction of the company in performing work, both practically and in the contractual agreement between the parties; and
B. Performs work that is outside the usual course of the company’s business; and
C. Is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the company.
The language of the ABC test provides potential exemption for some industries and professions. When evaluating the applicability of AB5 under the ABC test, the key element for most businesses is typically the third (C) prong.
The key point of (C) can be restated by asking whether or not the worker performs their work as part of his or her own business and offers the services to a number of other companies. In general, based on the preliminary analysis of AB5, there are seven categories of workers that are likely to be considered exempt from the provisions of AB5.
AB5 exemptions list
- Specific identified occupations – For this exemption to apply, the worker must be categorized as an insurance agent, lawyer, private investigator, accountant, direct sales person, commercial fisherman and similar occupations.
- Certain professional service providers – For this exemption to apply, the worker must offer certain contractual services related to marketing, HR, graphic design, photographers, barbers, cosmetologists, etc. and must meet the following six conditions. The worker:
- maintains a separate business location;
- has a business license for any project that will exceed six months;
- negotiates their own rates;
- sets their own hours;
- is engaged in an independently established business of same work; and
- exercises discretion and independent judgement for the services being performed.
- Real estate licensees – For this exemption to apply, the worker must be licensed under the California Business and Professions Code to conduct and participate in real estate transactions.
- Business-to-business relationships – For this exemption to apply, a service provider must establish a contractual relationship with their client and the following conditions must be in place. The service provider:
- is not controlled by the client;
- provides services directly to the client;
- has a written services contract;
- is required to have a business license or tax registration;
- has a business location that is separate from the client’s business location;
- is engaged in an independently established business of same work;
- has contracts with other businesses to provide the same or similar services;
- advertises and offers the same services to the public;
- has their own tools and equipment;
- can negotiate their own rates;
- sets their own hours and location for completing the work; and
- does not perform work that requires a license from the Contractors State License Board.
- Contractors and subcontractor in construction – For this exemption to apply, the contractor or subcontractor must meet the following conditions. The contractor or subcontractor:
- is working under a written contract;
- is licensed by the Contractors State License Board;
- is required to have a business license or tax registration;
- has a separate business location;
- has authority to hire and fire other workers to complete the work;
- assumes financial responsibility for errors in labor or services; and
- is engaged in an independently established business of the same work.
- Referral agencies and service providers – For this exemption to apply, the following conditions must be satisfied. The service provider:
- is not controlled by referral agency;
- performs work for the client in a location that requires the provider to have a business license or tax registration;
- must have a state issued contractor’s license;
- delivers services under his or her own name and not the name of the referral agency;
- owns the tools and supplies required to perform the services;
- is engaged in an independently established business of same work;
- has a clientele outside of restrictions from the referral agency;
- sets their own hours;
- sets their own rates; and
- is not penalized for rejecting clients or contracts.
- Motor club services – For this exemption to apply, the service provider must be in a contractual relationship with one or more motor clubs.
What about the Borello test?
Although there are a number of exempt occupations, it’s important to understand that the exemptions described above really only provide an exemption from the structure of AB5 amd not from the traditional considerations about whether or not a worker is properly classified as a contractor or an employee. So, even if a given worker is properly identified as an independent contractor and not as an employee, the analysis is not yet complete.
The Borello test (the “Right to Control Test”) has been in use in the State of California to classify independent contractors for more than 30 years. The Borello test is adapted from a decision made by the California Supreme Court in 1989 and uses multiple factors to determine whether a worker is an independent contractor or an employee.
Not all of the Borello factors have to be met to establish independent contractor status, and it’s generally viewed as a balancing of factors. The main thrust of the Borello test is to determine whether the “person to whom service is rendered has the right to control the manner and means of accomplishing the result desired.”
Basically, the relationship of the parties is evaluated by the level of control the employer has over the worker. The more control the employer has over the worker and the relationship, the more likely it is that the relationship will be viewed as employer-employee and not employer and independent contractor.
1. Control over Manner of Work. A worker is more likely to be considered an employee when the business has the right to direct and control the work performed by the worker, such as the time and place where the work is to be performed, the specific tools to be used or where the worker is to purchase supplies and services. Also, the more detailed the directions and instructions given to the worker, the more control the employer has and therefore the worker is more likely to be considered an employee. Similarly, if there are specific systems in place to measure and report the manner and nature of the work performed or if the worker is provided with ongoing training by the employer, the worker is more likely to be considered an employee instead of an independent contractor.
2. Control over Financial Details. To the extent that the employer is allowed to direct or control the financial and business aspects of the worker’s job, such as: (i) purchasing or providing equipment for the worker to accomplish the work to be performed: (ii) reimbursing expenses or paying the worker like an employee; and (iii) withholding taxes or deductions from the worker’s pay. In general, independent contractors generally provide their own tools and are usually paid a fixed rate or a flat fee at the end of a project. They also provide similar services for other companies as well, using their own tools.
3. Nature of the Relationship. This is largely a subjective analysis but how the worker and the business relate to each other and how they interact with each other can be indicators of the true relationship. To maintain status as an independent contractor, the worker and the employer should enter into a written contract outlining the work, method of payment and, most important, the end date of the project and the nature of the relationship. Using language in the contract that states the parties are entering into an independent contractor agreement and not an employment contract can be important. Also, independent contractors should not receive any benefits such as holiday or vacation days, medical benefits, or paid time off and should always be paid using a form 1099.
Are LLCs exempt from AB5?
No single business structure, including corporations, LLCs or partnerships, are exempt from AB5. But the following actions may enhance the probability of a worker being classified as an independent contractor.
1. Establish a business. Under both the ABC test and the Borello test, it is more likely that the worker will be viewed as an independent contractor if the worker has their own business entity. This means that being a sole proprietor is less favored when evaluating the relationship to determine independent contractor status. For example, under the third prong of the ABC test, a worker that is customarily engaged in an independently established trade, occupation or business is more likely to be deemed an independent contractor when they conduct business under the structure of an LLC or corporation. Establishing a separate business location, even if it’s a home office will also help.
2. Get an EIN or TIN from the IRS. Once the business has been structured, contact the IRS and obtain a Federal Tax ID (EIN or TIN) for the business. Use the Federal Tax ID for business tax returns and other tax liabilities because that will further establish the independent nature of the business.
3. Operate as a separate business. Legally structuring the business as an LLC or corporation is not enough. It’s important to have a separate business bank account and obtain any required business licenses in the name of the business. All contracts should be entered into in the name of the business. These steps will all help to demonstrate that the independent contractor is not an employee and therefore not subject to AB5.
4. Demonstrate independence in business operations. As a business owner, the independent contractor publicizes his or her own business, negotiates rates, sets working hours and has the equipment to provide its services to a variety of disparate clients. Another advantage of creating a separate entity, such as a corporation or an LLC, is to provide additional protection for the independent contractor’s personal assets by separating them from the business’s legal liabilities. This may also reduce the amount of taxes the independent contractor pays. Always consult with an attorney and CPA to determine the specific requirements and benefits of setting up a company to conduct business operations.
AB5 exemptions are subject to change
Before AB5 became law, multiple companies and industries were already lobbying to make changes to the language and enforceability of AB5.
For example, in a decision handed down by Los Angeles Superior Court judge William Highberger last January, it was determined that AB5 “prohibits motor carriers from using independent contractors to provide transportation services” and, accordingly, AB5 is preempted by the Federal Aviation and Administration Authorization Act of 1994. This meant that AB5 does not apply to truck drivers in California.
DoorDash, Uber and Lyft have successfully lobbied to get an initiative on the ballot for the November 2020 election cycle. The initiative, if successful, would exempt ride-hailing and similar services from AB5 while providing for increased compensation for drivers by requiring companies to pay them above minimum wage, plus 30 cents per mile. It would also mandate health care coverage for drivers who work at least 15 hours per week, and require companies to provide drivers with insurance for on-the-job injuries.
Other professions and lobbies are also trying to get AB5 changed or repealed. In all, 34 separate pieces of legislation related to AB5 were introduced in the California Legislature before the end of February 2020. Most of the bills seek to expand the list of occupations that are exempt employee classification under the ABC Test. Two of the bills would exempt pharmacists from AB5 and other proposals would amend the law to make clear that marriage therapists, youth sports referees and loggers should not be considered employees under the law.
On September 1st, 2020, the California State Legislature passed AB2257, which would exempt musicians, photojournalists, freelance writers, newspaper cartoonists, translators, appraisers and other occupations from the provisions of AB5. The bill awaits signature by Governor Gavin Newsom before it becomes law.
It’s still very early in the game, so it’s hard to predict how AB5 is going to be interpreted and enforced by the courts. The law has only been in effect since January and few court cases have addressed the scope and reach of AB5.
AB5 exemptions summary
- It’s the responsibility of each employer to properly categorize their workers as employees or independent contractors. If an employer classifies incorrectly or believes their industry or business is exempt, they may be liable for fines and penalties.
- Just because your business is exempt from the provisions of AB5, that’s not the end of the discussion. It’s still important to evaluate whether or not a relationship is an employee/employer relationship or an independent contractor relationship under the Borello test.
- Independent contractors may be able to bolster their legal position by setting up a limited liability company or corporation, getting an EIN from the IRS, and taking steps to act more like an independent contractor overall.
- Exemptions are very fluid right now and there will undoubtedly be many changes to the law and the application of the law as time goes on. Everything we know today may be wrong in a few months. Stay tuned and hang on. It’s going to be a wild ride.
Disclaimer – Yes, I’m a lawyer, but I’m not your lawyer. All information in this post is provided for educational purposes only and should not be considered legal advice for any specific person or specific situation.
About the author
Mark F. Wright, JD
Mark has extensive experience in the practice of law, business management, and engineering in a wide variety of corporate, government, and private sector environments. Mark has successfully assisted various small companies as well as Fortune 500 companies in developing their patent, trademark, and technology licensing portfolios, specializing in emerging computer hardware and software technologies.