California Worker Classification Fight Continues But Expect Enforcement by JONATHAN KALINSKI
COVID-19 has placed much of our normal activities on hold. It hasn’t, however, slowed down the maneuverings around California’s new worker classification law, known as AB5, which took effect January 1, 2020. Just before the law took effect, the trucking industry won a major victory when Judge Benitez of the Southern District of California issued a temporary restraining order. A few weeks later a preliminary injunction was issued. The case is currently pending before the 9th Circuit.
San Diego and Instacart are going toe to toe on the issue as well. The City initially was granted an injunction against Instacart, which was stayed when the company appealed. San Diego has now filed an appeal asking the injunction to be reinstated arguing that allowing Instacart to operate and misclassify workers during coronavirus will cause serious harm.
In April, Judge Chhabria of the Northern District of California, presiding over Lyft drivers’ suit against Lyft, denied the drivers’ request for an emergency injunction, but warned Lyft that it was obvious AB5 applies to its drivers and that if it resists reclassifying it would be disregarding the law.
On May 5, 2020, California sued Uber and Lyft in San Francisco Superior Court seeking to force the companies to treat its drivers as employees. The suit calls Uber’s and Lyft’s misclassification a “scheme”. On June 9, the California Public Utilities Commission held that Uber and Lyft drivers were employees under AB5. This decision is a blow to Uber and Lyft but is far from the final word. Uber, Lyft, and several other companies sponsored a ballot initiative for November and are pouring millions into the campaign. Labor unions are doing the same to oppose it.
The fight continues in Sacramento as well, as many industries continue lobbying for exceptions. There are several bills pending that would change parts of AB5. Perhaps the main one is AB 1850, introduced by Assembly Member Gonzalez, the author of AB5. AB 1850 would expand the business to business exception to individual workers and create additional exemptions.
As the battles in Court continue, businesses should not expect the EDD and other agencies to sit back and wait for everything to be resolved. That will likely take years. Those businesses not complying with AB5 risk being audited and having their workers reclassified to go along with additional taxes and penalties. The coronavirus pandemic may only make things worse for businesses. Unemployment claims have skyrocketed throughout the country and California is no exception. Some of these claims are being filed by workers who are treated as independent contractors. These claims are likely to trigger several audits. Businesses beware.
To recap for those who (somehow) still aren’t familiar with AB5. It codified the California Supreme Court decision in Dynamex, adopting the ABC Test to determine worker classification. In order to be treated as an independent contractor, businesses must show their workers satisfy all three prongs of the ABC Test. Some commentators acted like the ABC Test was new and rewrote worker classification rules. In fact, the ABC Test has existed for many years and is followed in whole or in part by nearly 30 states. The ABC Test is as follows:
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;
C: The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
For many businesses the B test, or integration, is the backbreaker. Lyft and Uber without drivers isn’t much of a rideshare company. The companies argue they are more like tech companies. Trucking companies without truckers won’t be too successful. Landscape companies without landscapers, etc., etc. Certain industries, such as entertainment, have taken a status quo or wait and see approach to AB5. Some read AB5 to be the end of loan outs, making actors and directors employees of the studios or production companies that use their services. Others argue that AB5 will have no affect or that an exception applies.
AB5 exempted certain professionals from the ABC Test including licensed insurance agents, licensed professionals such as doctors and lawyers, security brokers, direct salespersons, commercial fishermen, “other professional services” including estheticians and fine artists. If you qualify as one of these professions, you aren’t subject to the ABC Test, but you must still satisfy the old Borello factors. The pending legislation looks to expand the exemptions.
In addition to the above exempt professions, AB5 contains a business to business exception that may be the focus of many audits. To satisfy this exception, the worker must meet all 12 requirements. If you meet these requirements, you must still satisfy the Borello test.
- The business service provider must be free from the control and direction of the contracting business entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
- The business service provider is providing services directly to the contracting business rather than to customers of the contracting business.
- The contract with the business service provider is in writing.
- If the work is performed in a jurisdiction that requires the business service provider to have a business license or business tax registration, the business service provider has the required business license or business tax registration.
- The business service provider maintains a business location that is separate from the business or work location of the contracting business.
- The business service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed.
- The business service provider actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring entity.
- The business service provider advertises and holds itself out to the public as available to provide the same or similar services.
- The business service provider provides its own tools, vehicles and equipment to perform the services.
- The business service provider can negotiate its own rates.
- Consistent with the nature of the work, the business service provider can set its own hours and location of work.
- The business service provider is not performing the type of work for which a license from the Contractors State License Board is required, pursuant to Chapter 9 (commencing with Section 7000) of Division 3 of the Business and Professions Code.
Businesses must be proactive in reclassifying if they believe they misclassified workers in the past. Waiting for the courts or the legislative process to provide relief is risky and the costs of misclassification are high. Businesses, and the professionals who advise them can be subject the penalties.
Although CA law now differs substantially from Federal law in this area, it will be difficult if not impossible for businesses to treat workers one way for CA purposes and another for Federal purposes. Attempts to do so could lead to an IRS audit. The IRS has emphasized employment tax issues for several years now and I would expect AB5 to feed into that.
Businesses are focusing on surviving the pandemic, but they shouldn’t ignore worker classification issues. The AB5 fight wages in courts and the legislature, but the EDD will not wait.
Jonathan Kalinski is a principal at Hochman Salkin Toscher Perez, P.C. and specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world. He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.
Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters. Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters. Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.