Understanding Independent Contractors in California Post-AB5

The landscape for independent contractors in California has significantly changed following the enactment of Assembly Bill 5 (AB5).  AB5, which went into effect on January 1, 2020, codified and expanded the “ABC test” to determine whether a worker is classified as an independent contractor or an employee. This article provides a refresher on the ABC test, its use in various contexts, common misunderstandings, specific exemptions, such as those for independent-sales representatives, and the limited scope of Proposition 22.

The ABC Test 

The ABC test was first introduced by the California Supreme Court in the landmark Dynamex Operations West, Inc. v. Superior Court (2018) decision and was later codified into law by AB5. The test presumes that a worker is an employee unless the hiring entity can prove all three of the following conditions:

Autonomy: The hiring entity neither controls nor directs the worker, both under the contract and in fact.

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

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

Failing to meet any one of these conditions results in the worker being classified as an employee, subject to all labor protections and benefits afforded under California law.

Part B of the ABC test is often the most challenging criteria for businesses to meet because it requires that the worker perform work that is “outside the usual course of the hiring entity’s business.” This condition is difficult to satisfy because, in many cases, the work being performed by an independent contractor is closely related to the business’s core operations. And there is no exception for temporary workers unless those workers are employed by another company.  For example, if a company hires a freelancer to perform tasks that are integral to its main business activities, such as a restaurant hiring a freelance chef to develop its menu or cook during peak hours, it would be hard to argue that the work falls outside the usual course of business. This makes Part B a significant hurdle for businesses trying to classify workers as independent contractors, as it demands a clear separation between the company’s primary activities and the contractor’s tasks.

There are scenarios, however, where a worker could qualify as an independent contractor under Part B. For instance, if the same restaurant hires a plumber to repair or install plumbing fixtures, this work could be considered outside the usual course of the restaurant’s business. The restaurant’s primary business is food service, not plumbing, so the plumber’s work is distinct from the core business.  Thus, the plumber is almost certainly considered an independent contractor.  

Applications of the ABC Test

While AB5 primarily applies the ABC test in the context of the California Labor Code, the test is also utilized by other state agencies, most notably the Employment Development Department (EDD). The EDD uses the ABC test to assess whether workers are correctly classified for purposes of unemployment insurance, disability insurance, paid family leave, and other employment-related benefits.  Similarly, the Franchise Tax Board may use the ABC test to determine the correct classification of workers for state income tax purposes.  The ABC test may also be used by the Labor & Workforce Development Agency to determine who should receive workers’ compensation insurance coverage.

Common Misunderstandings

AB5’s passage has led to widespread confusion about what it means to be an independent contractor in California. Here are some of the common misunderstandings:

What It Means to Be Exempted (Borello Test)

Many industries and professions lobbied for exemptions from the ABC test, resulting in a complex landscape where certain workers are still subject to the traditional multi-factor Borello test. The Borello test, named after the 1989 California Supreme Court decision in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, considers various factors, including the business’s level of control over the worker, the method of payment, and the nature of the work relationship. 

For instance, medical doctors are among the professionals who have been exempted from the ABC test. Their classification is determined under the Borello test. However, this exemption does not extend to all healthcare providers; professionals such as chiropractors and acupuncturists are not exempt and are still subject to the ABC test. This discrepancy creates some confusion and challenges in the healthcare industry, as different rules apply depending on the type of healthcare provider.

And being “exempted” from the ABC test does not automatically mean a worker is an independent contractor; it merely means their classification is determined under the (relatively speaking) more flexible Borello test.

Independent-Sales Representatives (Not Direct Sales)

Direct salespersons who are not paid by the hour and have written independent contractor agreements fall under an exemption to AB5 and thus, are subject to the Borello test.  For example, a salesperson who sells products directly to customers in their homes or through online parties, such as a representative for a cosmetics or home goods company, would typically be considered a direct sales salesperson. These individuals operate independently, often working flexible hours and earning commissions based on sales rather than an hourly wage.

But independent sales representatives who are not involved in direct sales are still subject to the ABC test. These workers often incorrectly assume that their independent-contractor status is secure under AB5. Unless their work falls under one of the specific exemptions (e.g. business to business) or they meet the ABC test requirements, they must still be classified as employees. It is crucial for businesses and workers in sales to carefully assess their roles under both the ABC and Borello tests to avoid misclassification.

Limited Scope of Proposition 22

Proposition 22, passed by California voters in November 2020 and recently upheld by the Supreme Court, provides a carve-out for app-based transportation and delivery companies, allowing them to classify their drivers as independent contractors rather than employees. Prop 22’s scope is limited strictly to these app-based drivers, such as Uber and Lyft. Workers in other industries, even those performing similar tasks, are not covered by Prop 22 and must be classified according to AB5 and the ABC test. 

Conclusion

The classification of workers as independent contractors in California remains a complex and evolving issue post-AB5. Understanding the ABC test, the circumstances under which it is applied, and the various exemptions is crucial for both workers and businesses to ensure compliance with California labor laws. Misunderstandings can lead to costly misclassifications that could render the hiring entity a prime candidate for a class or representative action.

As California continues to refine its approach to worker classification, staying updated on legislative changes and court rulings is essential for anyone involved in the state’s labor market.