Independent Contractor Laws In California: Everything You Need To Know
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Employers who frequently work with independent contractors need to be careful. Employee misclassification and (accidental) tax evasion charges bear serious consequences such as financial penalties and legal liability.
Whether you're an employer or a worker in California, we’ve compiled all the relevant laws that regulate independent contractors as freelance workers and explained their impact on employers and workers alike.
In this article, we’ll cover:
- Independent contractor definition under California law (California Labor Code)
- What makes independent contractor status different in California:
- Assembly Bill 5 (AB 5), Assembly Bill 2557 (AB 2257) and the ABC Test
- The Dynamex decision
- The Borello test
- Fair Labor Standards Act and the “Economic Realities” test
- Fair Employment and Housing Act (FEHA) — and does it apply to independent contractors
- Penalties for employee misclassification in California
The independent contractor is defined under California Labor Code section 3353. An independent contractor is “any person who renders service for a specified recompense for a specified result, under the control of his principal as to the result of his work only and not as to the means by which such result is accomplished."
In other words, independent contractors enter into business for themselves, not on the employer’s (the principal’s) behalf. Their hiring party can have a say in the outcome of the work, but do not have a say in how the work is done. That means contractors have the authority to decide aspects like what their rate is, what working hours to follow, what equipment to use, and where they work from.
What makes a contractor a contractor
Freelancers and independent contractors take pride in having plenty of job liberties. However, with freedom comes some additional obligations. Contractors must cover legal matters that the employer would normally cover like payroll taxes and health benefits, while losing out on rights and benefits like overtime.
Independent contractors aren’t entitled to minimum wage, overtime pay, paid leave, rest breaks, and employee benefits such as retirement, health care and worker’s compensation insurance. Independent contractors pay self employment taxes to cover social security and medicare, additional medicare tax, and federal income tax. They have the right to decide who to work with and when to terminate the contract. They can hold multiple clients at the same time and get to keep all the profit earned from their own business.
US common law outlines three factors that determine whether a worker should be classified as an independent contractor:
- Type of relationship — are the workers hired for certain projects and in the specific time frame (IC), or they’re hired indefinitely and do the work crucial for the company (employee)
- Behavioral control — who has the right to control the way job gets done
- Financial control — who controls the business aspects, invests in the equipment, sets the rates
Again: the higher the independence and the more specific the tasks, the greater the chance this worker should be considered as an independent contractor.
Everything mentioned above applies to all independent contractors across the US. California in particular has a substantial history of contractor legislation, which has evolved into an elaborate set of classification tests.
The history of independent contractor status in California
The gig economy had inflated tremendously over the past two decades. Some of the growth can be attributed to employers “downgrading” employees to independent contractors as a way to reduce paying payroll taxes mandated by employment law—at the expense of their workers, who must cover additional costs with their own income.
This has resulted in several cases of misclassification, where employees have been improperly classified as independent contractors. Notable cases include the California Labor Commissioner’s suit against Uber and Lyft, but California’s development of contractor classification can be traced back to the Dynamex decision in 2018, which resulted in a new Californian law.
Assembly Bill 5 (AB 5)
California Assembly Bill 5 (AB 5) is a Califonian law that established the ABC Test: three conditions an employer must prove in order to classify a Californian worker as an independent contractor.
AB 5 came as a result of the Dynamex ruling, a 2018 case in the Supreme Court of California. In the ruling, the court noted that the existing Borello and FLSA contractor tests left too much space for interpretation and proved to be inadequate in the case.
AB 5, which came into law in 2019, established a special state statute, making the ABC test as the default legal test for contractor classification. It gives workers additional protection by putting the burden of proof of classification on the employer.
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The ABC Test—the main classification test
AB 5 established the ABC Test — a three-pronged test that requires the employer to prove all three of the following factors:
- “The worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact”
- “The worker performs work that is outside the usual course of the hiring entity’s business”
- “The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity”
The employer must prove all three standards in order to classify a worker as an independent contractor, otherwise the worker is considered an employee. But although this test is more restrictive, AB 5 (and AB 2257) granted exemptions to many jobs, services, and cases. Exempted occupations and industries are allowed to use a more flexible standard, the Borello test.
Assembly Bill 2557 (AB 2257)—new exemptions
California Assembly Bill 2557 (AB 2257) essentially amends AB 5 with expanded exemptions to the ABC test. The changes came after lobbying from many industries that felt the ABC test was too restrictive.
Exemptions currently include:
- Exempt occupations — many sorts of creatives (musicians, visual artists, performance artists, etc), translators, CA licensed veterinarians, lawyers, architects, dentists, physicians, surgeons
- Professional Services exemptions — freelance writers and photographers, graphic designers, certain travel agents, securities broker-dealers, administrator of human resources, etc
- Business-to-business exemptions — bona fide B2B contracting meeting certain requirements
Dynamex Operations West, Inc. v. Superior Court — The Dynamex Decision explained
Dynamex was a delivery service that classified their drivers as employees according to California’s wage and hour laws. In 2004, they converted their drivers to independent contractors.
Dynamex required workers to purchase their own vehicles and pay for fuel, insurance, maintenance, and tools required to complete the work. In addition, they had to acquire a cell phone to communicate with dispatchers and wear a “work uniform”—Dynamex shirts and badges—during working hours.
Dynamex didn’t guarantee the type or number of deliveries they’d assign to the drivers. They could lay them off whenever they wanted with a three-day notice. Workers were allowed to reject delivery tasks, provided that they let the dispatcher know. They could set their own working schedules but had to notify Dynamex about them in advance.
In 2005, a number of workers filed a class-action lawsuit against Dynamex in the Superior Court of Los Angeles. The main issue was the misclassification of employees as independent contractors, which deprived the employees of business expenses coverage and paid overtime.
Dynamex appealed several times. Before making the final decision, the ruling bodies tried deciding by examining two existing multifactor tests: the Borello test and the FLSA test.
California Wage Orders didn’t offer one precise independent contractor definition either — any person employed by the employer was considered an employee. Another earlier case, Martinez v. Combs, showed that there were three alternative ways to define what “employ” means:
- “to exercise control over the wages, hours or working conditions”
- “to suffer or permit to work”
- “to engage, thereby creating a common law employment relationship”
In the end, the California Supreme Court decided in the workers’ favor.
The Borello Test
The Borello Test is a multifactor test for classifying workers. The Borello Test is still in use today. Certain industries and occupations that have been granted a statutory exemption from the ABC test can use the Borello test.
The Borello test consists of multiple factors, which are all considered as a whole to determine a classification. No single factor controls the determination, which makes it a more flexible evaluation compared to the ABC test.
The Borello test was put together after a 1985 case, S.G. Borello & Sons, Inc. v. Department of Industrial Relations. The company failed to provide workers' compensation coverage for the migrant harvesters of their cucumber crops. Borello & Sons claimed that they were independent contractors, and as such excluded from the workers' compensation law.
Fair Labor Standards Act (FLSA) Test, or the “Economic Realities” Test
The FLSA test is applied by the California court, and it helps with determining the right worker classification.
Unlike the IRS common law prescriptions, the following factors aren’t considered when applying the FLSA test:
- The payment schedule and the way workers are paid
- The place where people work
- Whether the contractor is licensed by the local governing body or the state
- Whether there’s a written agreement about the worker’s status or not
What matters for this test is:
- Worker’s opportunity to make a profit or suffer from losses
- How involved the worker is in the employer’s core business aspects
- Relationship permanency
- How much the worker invests in working equipment
- The level of control workers/ employers have
- The way an employer’s business operates
The FLSA test is rarely used because it is quite different (and brings less advantage to workers) than the other means of worker protection. These standards are more vague when compared to the ABC test, FEHA and other labor rules and regulations in California.
Does California’s Fair Employment and Housing Act (FEHA) apply to independent contractors?
California’s Fair Employment and Housing Act prohibits employee discrimination on several protected categories, like race, age, and gender. But the law only applies to employees and not to independent contractors.
However, the FEHA does provide protections from unlawful harassment, and this protection includes contractors.
In the FEHA, “persons providing services pursuant to a contract” are protected from unlawful harassment — and the definition of such persons matches with the broad definition of independent contractors.
According to FEHA, “persons providing services pursuant to a contract”:
- Can decide upon the working place, time, and the way the work is performed
- Supply the work equipment on their own
- Does work that requires certain skills not usually needed in the company (for example, IT firm hiring a freelance copywriter)
IRS Form SS-8 for an official determination
In some cases, it might be difficult to determine the correct employment status, even after completing the IRS 20 Factor Test. Employers who wish to avoid employee misclassification penalties and cannot do this on their own have two options:
- Contacting a law firm with experts well-versed in labor law and relying on their advice
- File Form SS-8 with the IRS for an official determination
Both companies and workers are allowed to file this form to ask for a determination.
Form SS-8 requests you describe the concrete situation in detail; you cannot describe the hypothetical situation, just the one that’s currently going on. This is tricky because filing the Form SS-8 still means that you need to file an income tax return on time.
Penalties for employee misclassification in California
Employers who deliberately misclassify their employees as independent contractors are subject to various penalties from the IRS, California's Employment Development Department (EDD), the US Department of Labor and other institutions.
As mandated by California Labor Code - LAB § 226.8:
- Willful misclassification carries a civil penalty ranging from $5,000 to $15,000
- Willful misclassification behavior found to be repetitive carries a civil penalty ranging from $10,000 to $25,000 for each violation
Here, “willful misclassification” means “avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor”.
IRS penalties can be much more significant. Employers who attempt to misclassify the employees as independent contractors can be found guilty of a felony and charged up to $100,000; in some cases, they can be sentenced to spend up to 5 years in prison.
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Disclaimer: This article is intended for informational purposes and should not be considered legal advice. Consult a qualified licensed attorney for help on legal issues.