Welcome to a new year and new decade! With the turning of the year comes the resetting of tax filing deadlines. First up are 2019 W-2s for employees and 1099s for independent contractor services, both due January 31, 2020. California recently created a new test to differentiate independent contractors from employees. In this article we will discuss this test and why it is important to make sure the people you pay for services are properly classified.
Based on a 2018 California Supreme Court ruling, Assembly Bill 5 was signed into California law in September 2019. Effective January 1, 2020, the law requires use of the “ABC test” to determine who is an independent contractor and who is an employee of your business.
This distinction is important for several reasons, including who is responsible for employer payroll taxes and unemployment & disability insurance, as well as the worker’s eligibility for unemployment and company provided benefits like health insurance, retirement plan contributions, overtime, paid time off, and sick leave.
Under the ABC test, a worker is considered an employee, and not an independent contractor, unless all three of the following conditions are satisfied:
- 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.
Do you control the worker’s schedule, circumstances, performance, location, hours, pay rate or pay schedule? Do you reimburse for expenses, provide tools/supplies? Do you provide the worker any benefits?
- The worker performs work that is outside the usual course of the hiring entity’s business.
Does the individual perform tasks on your behalf that you, or your employees, normally would undertake, or is the work directly related to your business’ services or products?
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
Do they perform services for a variety of different customers/clients?
Meeting all three conditions to establish independent contractor status can be more challenging than under prior law. It is presumed that workers are employees unless proven otherwise through application of the ABC test.
If it is determined that the company has improperly classified a worker as an independent contractor, an arduous compliance process may follow. The company may be required to amend payroll reports and W-2s, corrective payroll tax payments may need to be made, and penalties and interest could be assessed.
If your company is subject to the new law, it is important to carefully identify workers that may fail any of the three conditions of the ABC test. For those workers, consider discussing with your attorney whether service contracts can be adjusted to better reflect independent contractor status or whether the worker should be classified as an employee. Once determined, the relevant factors of the relationship driving the decision should be well documented.
Please note that the ABC test, as described above, is not used to determine employment vs. contractor status for all industries and individuals. Certain licensed insurance agents, medical professionals, attorneys, architects, engineers, and accountants are permitted to use other tests.
If you have questions regarding independent contractors and/or employees, please give us a call at (858) 558-9200.