In late 2019, California legislature passed a controversial new labor law that was put into effect on January 1, 2020. Assembly Bill 5, or AB5 as it’s more commonly known, set a new standard for hiring independent contractors or “Gig Workers”, requiring many to be reclassified as employees covered by minimum wage, overtime pay, workers’ compensation, unemployment and disability insurance. Business owners also have to cover employees’ Social Security and Medicare taxes.
This new Law has prompted lawsuits and a multimillion-dollar ballot initiative sponsored by Uber, Lyft, Postmates and DoorDash; huge tech employers who have successfully thrived on a model that allowed tens of thousands of people to earn extra income as independent contractors in places where the income to cost of living gap is very large, or where opportunity for traditional work is less available. Changing this model threatens to paralyze these companies and cease to provide such opportunities to the people who are currently benefiting from them.
And, though most of us have heard about the battle between these mega-companies and the State of California over this new legislation, the fact is that this doesn’t just apply to these large companies. Small businesses are positioned between the crosshairs as well and face much quicker consequences with far more limited resources and fiscal flexibility.
Let’s consider a small yoga studio in Echo Park that had to reclassify its yoga instructors, some of whom only taught one class a week. Under the new law, the following conditions had to be met if the studio wished to continue to classify their instructors as an independent contractors:
- (A) The person 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 person performs work that is outside the usual course of the hiring entity’s business.
- (C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Where most employers fail to avoid this criterion is the second condition, “B,” which states that if the contractor’s work activity matches the trade of the employer, that the contractor must then be reclassified an employee. We can easily see that Uber would have a hard time proving that driving services conducted by an Uber driver could be defined as being “outside of” Uber’s primary course of business. In the same way, the small yoga studio in Echo Park could not avoid reclassification of their instructors.
When AB5 was approved, the internet was quickly flooded with editorial pieces and YouTube videos that criticized the new bill. The intensity of blow-back may soon become a strong enough cause for law makers to reconsider this unprecedented, contentious rule, but before this bill can ever be repealed small business owners must consider taking action to avoid the harsh penalties for failing to comply. Sadly, this means more costs taken form the bottom line of the business for pricey programs and policies that must now be acquired.
The alternative to shelling out the cash for new insurance plans and paying more taxes is the risk of having to pay hefty fines. On top of being mandated to retroactively cover overtime pay and compensation for meals and rest breaks during any period where workers were not classified properly, penalties include:
- – Paying for unpaid payroll back-taxes and penalties
- – Up to a $10,000 fine for failing to have workers compensation insurance;
- – Additional fines of $5000-$25,000 per employee if found guilty of “willful misclassification.”
Business owners may also be liable for unexpected unemployment insurance and workers compensation payments, and employee discrimination claims. Under AB5, every time a contractor is hired and are paid more than $600, an employer has to report it to the EDD within 20 days of the date of hire. If the deadline is missed, EDD may pursue a tax audit of the business. In other words: more fines and penalties.
As business Brokers who work with small businesses on daily basis, we can see how unfair this law can be to many small businesses. Those of us who can see the destructive nature of this bill can voice our criticism through social media and groups within to support each other and share knowledge and resources for help. But, it is of the utmost importance that business owners consult with labor law attorneys to determine the best course of action for protecting their business and their assets from being eaten away by unnecessary fines, penalties and consequences.
Helen Liu is the Principal Broker and President with Sunbelt Business Advisors. She can be reached at (408) 436-1900, or at [email protected]. Or connect with Helen on LinkedIn.