California’s AB-5: What is It and Why Should You Care?

“Facts that provide evidence of the degree of control and independence fall into three categories:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The key is to look at the entire relationship and consider the extent of the right to direct and control the worker. (https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee).

Employers Have Misclassified Employees For Years

Under the IRS analysis, many workers classified as independent contractors, could not pass the test if challenged.

When I first began working for law firms I saw employers wrongfully classify paralegals and/or law clerks as “independent contractors.” These workers were on a schedule, worked 8-5, were required to be in the office during their assigned hours, used company resources and equipment, were not licensed business owners, and were required to work under the explicit direction of a supervisor. There was nothing independent about the position.

I remember a story from law school about how an ambitious, smart attorney drafted an independent worker contract for dancers at a gentleman’s club – a strip joint.

I could probably argue both sides of an IRS analysis under these circumstances. First, the contract insured the dancers were charged hourly for their use of the tools of their trade – the stage. One could argue that young women dancing partially naked was not “service performed outside the usual course of business of the employer;” that the usual course of business of the strip club was, well, stripping dancers. On the other hand, one could argue that the “usual course of business” of a gentleman’s club was selling alcohol. I would argue that the dancers are merely a “marketing tool” by which the club hopes to sell more alcohol, like having music playing in a restaurant; that the business does not make money off of the dancing, but merely the alcohol sales, therefore, they are not in the business of dancing.

The point is, as long as the IRS has distinguished between employees and independent contractors, crafty business owners and motivated attorneys have been finding ways around the classifications.

Here Come The Trucks Again

Many trucking companies have been based on a business model which requires all of their drivers to be classified as independent contractors. Some, who are owner operators, may qualify under the IRS analysis; most would not.

This is where my struggle comes in. The trucking industry is now threatening adverse consumer impact from the inability of the industry to carve out an exception for themselves. https://www.freightwaves.com/news/hundreds-of-truckers-protest-ab5-at-southern-californias-busiest-ports

I have seen trucking companies that are creative, albeit not IRS compliant, with their employment classifications. Virtually every one who drives a truck for them is classified as an independent contractor. A driver may use or on paper “lease” a company truck, be docked for gas and sometimes expenses, but they must work only those deliveries dispatched by the employer and they are under strict control. The company negotiates the contract and then “informs” the driver of the driver’s rate. Of course, the company takes the largest cut.

AB-5 Versus IRS Rules

Freight delivery is the business of the trucking company, so obviously this would never pass the three-part test under AB-5. But also, under the long-existing IRS rules, a driver who does not own the truck he drives, would not likely pass the long-held IRS analysis either. But, this is how the trucking industry has been so profitable in the past. They do not pay employment taxes or any sort of benefit for those who actually facilitate the objection of their business. The company takes the largest portion of the rate for each mile driven, negotiates the contracts, deducts for dispatching, and the driver is only lawfully on the road under the company’s DOT authority. And, most importantly, the driver does not actually own the truck they are driving.

If a driver owns their truck, has a business license, controls their own routes and contracts, pays their own self-employment tax, and has their own licenses and DOT authority, they may qualify as an independent under IRS rules and/or AB-5, if they merely use another company for dispatching. Under AB-5, the dispatching company cannot be in the business of freight hauling, only dispatching.

Therein lies the problem in the collective mind of the trucking companies. If all they do is dispatch (because they do not want the extra cost of “employees”) they cannot take the largest percentage of the contracted rate. I don’t see AB-5 as altering the law, but more clarifying what it has always been. AB-5 is a manifestation of the state’s intention that they will no longer look the other way when an entire industry skirts the IRS definition of an employee.

It is likely that truck drivers who drive a company rig have always been employees under IRS rules. And, they should be treated as employees. If a driver owns his own truck, has his own DOT authority and merely uses another company to facilitate or broker dispatching, then further IRS analysis would be necessary. I am okay with this. This makes sense. I think out of greed, business owners have so diluted and obscured the definition of employee versus independent contractor that it no longer bears a relation to the actual IRS rules.

Other Industries and AB-5

I once spoke to a couple in the business of scripting, producing and photographing or videoing promotional material, commercials and marketing material. The man was the “artist” and the wife handled the business and bookkeeping for the business. Often, the business could fulfill a request and produce the product by themselves. Sometimes, the work required an actor, or maybe even a second camera operator or editing professional. Not often, but sometimes.

Under the three-part test of AB-5 and Dynamex, this couple was in the business of producing promotional and/or commercial videos. And, at least on the surface, could not contract with an independent worker to perform services for a week or two, if the hired services were the same as their company’s regular course of business, making a video.

It would not make sense to require that a small business such as this hire individuals for a week or two, set up and pay employment taxes, hire a payroll company to insure the deductions and quarterly payments to the government are timely, and all that is associated with having employees.

This situation is not the same as a truck driver, who works for ten years driving a company truck and yet is classified as independent and not as an employee.

And yet, under AB-5 the couple is required to hire needed workers as employees, no matter how long their service is needed. Small business owners trying to stay AB-5 compliant are faced with the reality of hiring and laying off employees who are only needed for a short duration.

What is The Solution?

There is certainly a place in society for gig workers and independents in many industries. However, with the patchwork-quilt of exceptions to AB-5, we now have a law which allows a driver for Uber to be exempt from the three-part test, but not a truck driver who is essentially in the same predicament – performing a service which is exactly the same as the usual course of business of the employer.

AB-5 became entangled in a sea of inconsistencies while still in the legislative committees. Some, but not all affected industries began lobbying for exceptions. App based, ridesharing businesses spent billions of dollars insuring passage of an initiative to secure their exception. And now, ironically, the very industry which was the stated target is exempt from AB-5. Many more in the gig industry are not so lucky. In the big picture view, the law makes no sense now.

Throw it out and start over. The stated justification for AB-5 was to protect drivers with app based ridesharing companies. The drivers, indeed the majority of California voters, have decided they do not want that protection; these gig workers enjoy the freedom. Many use rideshare driving as supplemental income. Consumers like the inexpensive, readily available, flexible, app based option. With the passage of Prop 22 the entire stated purpose of the law is now moot. And, most importantly, we now have a piecemeal law which applies unequally to different workers in the same business model.

Perhaps it is time to work on drafting a new law; one which protects workers from greedy tax usurping employers, and makes sense; which treats all workers under the same analysis, while acknowledging society’s shift to a gig economy. And certainly, make sure any new law does not classify a creative worker needed for one or two weeks as an employee.