California’s Assembly Bill 5 (aka AB 5) continues to make news. Despite the trucking industry trying to steer clear of that law, in March 2024, the California Trucking Association (CTA) and the Owner-Operator Independent Drivers Association (OOIDA) faced the latest decision from the US District Court for the Southern District of California that rejected the sector’s arguments that the law shouldn’t regulate owner-operator truck drivers.
That’s not the first time the law has been challenged, and likely won’t be the last. At the end of June 2022, the Supreme Court declined to review two cases on the statute’s constitutionality. However, the Supreme Court’s dismissal didn’t preclude future lawsuits either.
Several organizations that rely on independent contractors, including the International Franchise Association, have also been fighting AB 5 and similar legislation in courts over the last several years. Some of these legal battles have not had the outcome these organizations and companies have been seeking, while others have been able to secure the result they’ve wanted. Lyft, Uber, DoorDash, Instacart, and Postmates funded ballot initiative Proposition 22 (Prop 22) to exempt rideshare, app-based driver business models, and delivery businesses from AB 5. It became law after the November 2020 state election and has been appealed, but it remains in effect.
From the beginning, there have been mixed reactions for and against AB 5, Assembly Bill 2257 (aka AB 2257, which is AB 5’s modified version, expanding the exemptions list), and Prop 22. The exemptions also continue to raise concerns for lack of clarity. Time will determine the long-term impact of this legislation, but some preliminary research published earlier this year indicates that self-employment and employment overall in affected occupations in California decreased by 10.5 percent and 4.4 percent on average after AB 5 was implemented.
Regardless of how you feel about AB 5 and similar legislation that has followed, if you use contractors who are performing work in California, whether or not your company is based in the state, you need to remain compliant with the law. That begins with understanding its rules and what they apply to, so here’s an overview of AB 5.
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What is California Assembly Bill 5 or AB 5 and AB 2257?
AB 5 is a California labor code that was signed into law by Governor Gavin Newsom in September 2019 after being approved by the state’s Senate and Assembly, and it took effect on January 1, 2020. It was introduced by California assemblywoman Lorena Gonzalez, and aimed to reclassify many gig economy workers as employees rather than independent contractors.
The law codified a three-part test (known as the “ABC test”) for the Dynamex decision (see below), which determines a worker’s classification and affects various industries and companies relying on independent contractors. The ABC test replaced the previous standard for wage order claims outlined in the 1989 decision S.G. Borello & Sons, Inc. v. Department of Industrial Relations.
This change gave gig workers benefits, including minimum wage, sick leave, overtime, disability insurance, and unemployment with certain professions exempt from it. That list of exemptions expanded when AB 5 was repealed and replaced with AB 2257 in September 2020, adding 52 more exemptions for a total of 109. Here are examples of some of the professions that are exempt:
- Doctors
- Dentists
- Freelance writers
- Stockbrokers
- Degreed professionals, such as lawyers and accountants
- Insurance agents
- Real estate licensees
- Travel agents
- Licensed service trades, such as estheticians, electrologists, manicurists, barbers, and cosmetologists
Certain business-to-business contractors and referral agencies are also exempt, as are those engaged in a number of professional services and the music and entertainment industries. Some additional professions are exempt from certain requirements. For example, commercial fishermen are exempt from everything but unemployment insurance until January 1, 2026.
Also keep in mind that while these professions are exempt from the ABC test, they still could be subject to other standards for classifying workers such as the Borello test. In addition, at the beginning of 2024, the US Department of Labor (DOL) released the final rule, which evaluates employee or independent contractor status under the Fair Labor Standards Act (FLSA) with these six factors:
- Opportunity for profit or loss depending on managerial skill
- Investments by the worker and the potential employer
- Degree of permanence of the work relationship
- Nature and degree of control
- Extent to which the work performed is an integral part of the potential employer’s business
- Skill and initiative
Note that the final rule doesn’t override AB 2257 and the ABC test. California state law supersedes it.
Why AB 5 and AB 2257 have been a big deal for California employers
The distinction between who qualifies as an independent contractor versus an employee is highly significant. That’s because contractors aren’t entitled to the many protections many laws provide employees. When AB 5 was enacted, the many contractors who didn’t receive the below protections and benefits became entitled to them.
These protections include:
- Coverage by workplace discrimination laws
- Eligibility for overtime pay
- Coverage by workers’ compensation statutes
- Collection of post-termination unemployment
- Eligibility for health insurance and other employee benefits
There are several key differences between how a company interacts with an employee compared to how it interacts with an independent contractor.
| Employee | Independent contractor | |
| Hiring | Typically fills out an employment application, meets with HR, and completes additional requirements (such as a background check and drug test) before hiring | Typically interacts with the person or department needing services and may submit a proposal; signs a contract or statement of work before starting work |
| Taxes | Customary withholdings are taken from wages (payroll taxes, Social Security, etc.); all money paid during the tax year is reported on a W-2 | No withholdings are taken from wages; all money paid during the tax year is reported on a 1099 |
| How they’re paid | Earns either an hourly wage or a salary | Paid by the job, either in total when it is completed or incrementally per a fixed schedule |
| When they’re paid | Paid from payroll per a fixed period that cannot be changed (weekly, every other week, twice per month, monthly) | Paid by accounts payable whenever an invoice is submitted |
For this reason, any law that reclassifies a large group of workers is crucial for business owners who hire independent contractors. The misclassification of workers allows cities in the state of California or its Attorney General to sue employers, such as when Los Angeles, San Diego, and San Francisco sued Uber and Lyft.
What does the Dynamex ABC test have to do with AB 5 and AB 2257?
In Dynamex Operations West, Inc. v. Superior Court of Los Angeles County, the California Supreme Court decision set forth the three-part ABC test to determine whether a worker is an independent contractor or an employee. AB 5 codified it, which says that workers are “properly considered” independent contractors only if they meet the following three criteria:
| Criteria | What it means |
| (A) “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 “control and direction” test is what the IRS usually uses to define an independent contractor. It looks at three key points of control: behavioral (who controls the how, what, and when of the work), financial (does the workers have the opportunity not only to make a profit through the work but also take a loss), and relationship (is the worker limited only to working for the one business, or are they free to work for others). |
| (B) “The worker performs work outside the usual course of the hiring entity’s business.” | This factor looks at whether the work performed is outside the core function of the business. Think of functions such as IT maintenance, which a company can easily outsource. |
| (C) “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.” | This factor examines whether the worker is traditionally engaged in their own business. If not for AB 2257, professionals with degrees (e.g., lawyers and accountants), those engaged in licensed service trades (e.g., barbers or massage therapists), and traditional freelancers (e.g., landscapers and artists) could all qualify as contractors under this factor, if they weren’t exempt. |
As you can see from the ABC test for contractors, AB 2257 (which amended parts of AB 5 while retaining the ABC test) impacts the gig economy. Before getting into that, let’s first understand this “gig economy” industry we’re discussing.
What exactly is the gig economy?
The gig economy is a labor market characterized by short-term contracts or freelance work, not permanent jobs. Gig workers are independent contractors that business owners hire to help with specialized work and/or short-term work that doesn’t require a full-time hire.
Small business owners often connect with gig workers through apps or other online platforms. Think Upwork, Fiverr, and other part-time job sites.
Freelancers (the gig workers) can choose jobs or projects from anywhere in the world, and employers can access a wider pool of workers for projects. Moreover, gig work allows people to change jobs with the flexibility of choosing when and where to work. Gig workers also enjoy the work-life balance afforded by a career that permits total control over work schedules.
How should California small businesses ensure they’re compliant with AB 2257?
Because of how the law defines an “independent contractor,” there are specific steps that California gig employers—and any California business that employs independent contractors (which includes many small companies)—should be doing.
1. Lawyer up
If you work with independent contractors, hire an employment lawyer to analyze your team.
This will help you determine whether your workers are correctly classified as independent contractors. And if they’re not, the analysis will tell you how much your potential exposure could be for unpaid overtime, health benefits, and other compensation if you leave them misclassified.
2. Reclassify your team if necessary
After applying the ABC test above, you may realize that some of your workers are employees. Better late than never. If you need to reclassify an independent contractor to an employee, you must ensure all employment requirements are taken care of.
Your employee will need to:
- Complete an employment application
- Undergo a background check and drug test (if that’s your normal practice)
- Complete an I-9 and a W-4
- Enroll in your employee benefits program
You will also have to register your new employee with whatever agencies your state requires (for example, for purposes of workers’ compensation and unemployment coverage), and you will have to add your employee to the payroll.
You must also ensure that your employee receives (and signs a receipt for) your employee handbook and begins properly tracking their time for payroll and overtime purposes.
3. Figure out how you will pay for any reclassifications
Large companies may be able to absorb the costs of increased wages and benefits that accompany the reclassification of independent contractors to employees. Small businesses, however, can struggle to do this without proper planning.
You’ll either absorb the cost or pass it on to your customers. Either could result in a steep financial loss, so review your business finances to see where you could make cuts or change pricing to come out ahead.
4. Limit your team’s schedules
Consider assigning set work schedules if you need to reclassify your contractors to employees. This will help you avoid, as best as possible, your gig employees working too many hours (and earning potentially unlimited overtime premiums as a result).
5. Account for paid rest breaks
If you must reclassify your contractors to employees, ensure you give them sufficient time away from work. For example, California law requires that employees receive a 10-minute paid rest break for each four hours worked and a 30-minute paid meal break for each five hours worked. Failing to give this time to your new employees will result in liability under California law.
