Ernst & Young LLP Special Report, Unemployment Insurance, Worker Classification

California law reduces population of workers that can be treated as independent contractors

On September 11, 2019, the California Senate passed legislation under AB-5 to codify the California Supreme Court decision in Dynamex and expand and clarify its application.  This bill would significantly impact all industries that customarily engage independent contractors.

California’s pioneering independent contractor legislation could have broad implications on the gig economy (e.g., rideshare and delivery drivers) and is certain to trigger a larger national discussion.

California’s pioneering independent contractor legislation could have broad implications on the gig economy (e.g., rideshare and delivery drivers) and is certain to trigger a larger national discussion.

Governor Newsom has signaled his support for the bill and is expected to sign it into law within the coming days. 

Background

Prior to April 30, 2018, and for most matters before the California Division of Labor Standards Enforcement, depending on the remedial nature of the legislation at issue, the “multi-factor” or the “economic realities” test was applied under the California Supreme Court case of S. G. Borello & Sons, Inc. v Dept. of Industrial Relations (1989) 48 Cal.3d 341 (Borello). In applying this economic reality test, the most significant factor considered was whether the person to whom service is rendered (the employer or principal) has control or the right to control the worker both as to the work done and the manner and means in which it is performed.  There were an additional 11 factors also considered. 

Effective April 30, 2018, the California Supreme Court issued a landmark decision in the matter of Dynamex Operations West, Inc. v. Superior Court of Los Angeles.  In Dynamex, the California Supreme Court created a presumption that a worker who performs services is an employee not an independent contractor and adopted a new worker classification standard.  The result of the Dynamex case was to replace the Borello standard with the new ABC test.  The Dynamex holding was narrow in its application as it was limited to wage orders that were issued by the Industrial Welfare Commission. 

For unemployment and disability insurance purposes. whether a worker is an employee or independent contractor is currently determined through the application of the factors contained in common law or employment and statutory provisions of the California unemployment insurance code. The California Employment Development Department provides a questionnaire in DE-38 for this purpose.

Key provisions under California AB-5

  • Codifies the Dynamex (ABC test) standard.  California AB-5 codifies Dynamex (the ABC test) for purposes of the California labor code, the unemployment insurance code and for the wage orders of the Industrial Welfare Commission.  Accordingly, 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 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.

  • Retains current exceptions for the definition of employee. Any exception to the term “employee,” “employer,” “employ,” or “independent contractor,” and any extensions of employer status or liability, shall remain in full effect. (California AB-5 2750.3(a)(2).)
  • Reverts to Borello standard (i.e., old standard) in some cases. If a court of law rules that the new standard (i.e., ABC Test) cannot be applied to a particular case, the determination of employee or independent contractor status shall instead be governed by the old standard (i.e., Borello). (California AB-5 2750.3(a)(3).)

  • Exempts certain occupations from Dynamex (ABC test).  The law would exempt specified occupations from the application of the ABC test and would instead subject them to the application of the older standard (i.e., Borello). These exempt occupations would include, but are not limited to, the following: 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. (California AB-5 2750.3(b).)

Effective Date Under AB-5

California AB-5 provides that the codification of the ABC Test is not a change in law, but rather declaratory of existing law and should apply retroactively to existing claims to the extent permitted by law. 

Generally, and except where otherwise noted within the law, the other provisions of AB-5 are effective with work performed on or after January 1, 2020.

Any worker who is an employee by application of this law is not required to be covered by worker’s compensation insurance until July 1, 2020.  (AB-5 Assembly floor analysis, 9-10-2019.)

Observations

Tightening the worker classification rules so that more workers are eligible for benefits, like unemployment insurance, and protections, like minimum wage and overtime, is something other states are also considering (e.g., Alaska, New York and Oregon). There are also federal proposals similar to California AB-5 being promoted by federal lawmakers with an emphasis of giving gig workers the right to union representation.    

California AB-5 and similar legislation is likely to face fierce challenges from businesses reliant on gig workers, making the outcome uncertain.

Finally, implementation of the law will be complex requiring detailed guidance from the California agencies concerned with worker classification. 

In the meantime, businesses will need to consider the employment tax and human resources policy changes that will be necessary to comply with California AB-5 once enacted.

View the Ernst & Young LLP tax alert here.