California worker classification law stokes worries

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California Assembly Bill 5, which went into effect Jan. 1, 2020, was intended to protect workers in the gig economy by reclassifying many of them as employees, rather than independent contractors, including those who drive for Uber and Lyft.

Supporters of the law claim it will benefit workers by allowing them the ability to organize, as well as to claim overtime pay, unemployment insurance and workers’ compensation. Critics say that it will hurt small businesses such as cleaning services that rely heavily on independent contractors, since they won’t be able to hire their extra workers as employees, and will be forced to forego some of their larger jobs.

The law essentially codifies the “ABC Test,” which tips the independent contractor-employee classification heavily in favor of employees. In order to be considered an independent contractor, a worker would have to meet all three prongs of the ABC Test:
A. 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.
B. The worker performs work that is outside the usual course of the hiring entity’s business; and,
C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Connecticut has an ABC test under case law, according to Michael Knight, a CPA and partner in Fairfield, Connecticut-based Knight Rolleri Sheppard CPAs LLP.

“It’s an albatross around the neck of self-employeds,” he said. “They can be good on the federal side because they follow straightforward rules, but the ABC test is an amorphous test that captures anybody.”

The expectation is that more states will follow California’s lead and codify the test, according to Nancy Dollar, an associate at law firm Hanson Bridgett. Three other states — New York, New Jersey and Illinois — are considering similar bills.

“Our clients are very concerned about this,” she said. “Dynamex Operations West v. Superior Court was the California Supreme Court’s ruling that set forth the ABC test in 2018. AB 5 takes that test and puts it into law. It shifts the burden heavily in favor of a default classification of a worker as an employee.”

“What’s difficult is that it’s not a multifactor test where you can say, ‘We’re good on this one.’ You have to meet all three of the tests,” she said. “Otherwise you are an employee. It’s much stricter than prior case law.”

The Dynamex decision came out only within the last two years, Dollar observed: “A lot of businesses claimed that Dynamex did not apply to them. AB 5 codified this, and clarified it by defining who it applied to. It gives exemptions, but they are very narrow. A lot of lobbyists didn’t get their way, and a lot of our clients will be shocked. Most will find that they are subject to the ABC test.”

Certainly there will be a big fight, even a constitutional challenge,” she predicted. “Uber says it won’t reclassify its drivers because, as a tech platform, their work falls outside its usual course of business. Uber, Lyft, eBay, Airbnb and other third-party platforms will claim that their business is not providing services — they are simply an intermediary platform for a digital marketp. That’s what they would argue to get out of the second prong of the test.”

This can be supported by the way the company reports payments to the workers, Dollar indicated. ”Companies handling payments to third parties have the option of using Form 1099-K rather than the 1099-MISC typically supplied to independent contractors,” she said. “By doing this, the companies are positioning themselves as a ‘TPSO’ or third-party settlement organization.”

“A 2018 private letter ruling from the IRS affirms that a ride-share company is a TPSO so it can use Form 1099-K,” she said. “It also said that multiple riders would be considered part of a single transaction for purposes of payment reporting on Form 1099-K. This is important because AB 5’s reporting thresholds are high. It applies only to workers with more than 200 transactions and $20,000 in income in a year.”

The fight has just begun, according to Dollar. A case filed on Dec. 30, 2019, by Uber and a number of workers seeks “declaratory, injunctive and other relief” determining that California Assembly Bill 5 is unconstitutional.”

The pleading states that AB 5 violates the equal protection and due process clauses of the 14th Amendment to the U.S. Constitution, the Ninth Amendment, and the contracts clause of Article 1 of the U.S. Constitution, as well as the equal protection clause, the inalienable rights clause, the due process clause, the “Baby Ninth Amendment,” and the contracts clause of the California Constitution.

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Gig economy Employee classifications Uber Lyft