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The Complexities of HR laws in California [ Employee vs. Contractor ]

Updated: 4 days ago

California's HR laws differ from those of most other states, requiring thoughtful consideration by employers to avoid legal challenges. These onerous rules and regulations help maintain a healthy workforce and protect employee rights. However, this also means employers are left to navigate these complex requirements in order to avoid penalties and, potentially, legal action. The employee vs. contractor classification in California is among the most complex. The state's rigorous labor laws and legal precedent favor employee status, so it is critical to understand the complex set of criteria to determine whether a worker falls into the contractor category if they intend to use independent contractors.

employee and contractor discussion

The Importance of the Employee vs. Independent Contractor Classification

Independent Contractors, as the name implies, carry independent decision-making authority over their time and resources. They are compensated based on the performance metrics or outcomes outlined in the terms of their contract and are not eligible for overtime, worker’s compensation, state disability insurance or unemployment insurance. Independent Contractors are also not protected by CA wage and hour laws, including harassment, bullying, discrimination, and retaliation protections.

Moreover, employees can ask for support through state agencies like the Labor Commissioner's Office to enforce these laws. Yet, independent contractors must turn to alternative channels outlined in their contracts.

How Does Assembly Bill No. 5 Regulate the Employee vs. Contractor Classification?

Assembly Bill 5 (AB 5) is a California state law that went into effect on January 1, 2020, after Governor Newsom signed it into law in September 2019. AB 5 addresses the workers' employment status, and sets the standards for an employer to determine whether a worker(s)should be classified asan independent contractor instead of an employee.

A set of guidelines called the ABC test are used to make a determination between contractor or employee. The ABC test requires a worker to meet all three of these conditions in order to qualify as an independent contractor:

  • The worker controls how they perform the work according to the contract, and in reality;

  • The work performed by the worker isn't part of the usual activities of the hiring entity's business, and;

  • The worker usually engages in an independent trade, occupation, or business similar to the work performed.

How can employers apply the ABC test to worker relationships?

It’s important to remember that the Labor Code starts with the assumption that all workers are employees. The ABC Test allows employers to show that workers meet the qualifications to be treated as independent contractors, but all three steps must be met. The following summary clarifies how to apply each of the three steps.

Part A

Determine if the employer controls how and when the worker performs the work under the contract, and in practice. The employer must demonstrate that the worker is, in fact, free of the company’s control to meet this part of the test. The worker must also provide their own tools to complete the work.

However, if the worker is subject to the type and degree of control typically exerted over employees, such as how and when the work is completed, they fall under the employee status.

Part B

The next step is to establish whether the worker performs tasks outside the company's usual business by demonstrating that the work falls outside the employer’s regular operations.

Contracted workers providing services similar to existing employees are likely considered part of the usual course of business.

Here are the examples of services outside the company's usual business:

  • A company hires an outside landscaper to maintain the grounds of its retail store.

  • A tech startup hires a freelance graphic designer to create marketing materials for its company.

However, the following examples show when services fit the usual business:

  • A clothing manufacturing company hires a work-at-home tailor to make dresses.

  • A bakery recruits cake decorators to work on its custom-designed cakes.

Part C

The employer must be able to show that the worker is customarily engaged in an independently established trade, occupation, or business of the exact nature as the work performed for the hiring entity.

For instance, the employer can't unilaterally determine the worker's status by labeling them an independent contractor, or by requiring them to enter a contract. The worker must have an independently established business, meaning they perform this same type of service for multiple entities, at the time of work performance.

Individuals deciding to go into business typically take steps to establish and promote their business, such as incorporation, licensure, and advertisements. However, the hiring entity fails to meet the third step if a worker relies only on them.

For example, if a taxi driver must hold a municipal permit usable only while working for a specific company, that company doesn't fulfill the requirement.

Is the ABC test required for all occupations?

The answer to this question is actually no. There are many cases when the employer can rely only on the Borello test, which was in place prior to AB5, and other cases where the Borello test can be used when certain conditions are met. Here is a summary:

  • Certain occupations in connection with creating, marketing, promoting, or distributing of sound recordings or musical compositions

  • Certain licensed insurance agents, brokers, and persons who provide underwriting inspections, premium audits, risk management, claims adjusting, third-party administration consistent with use of the term “third-party administrator,” as defined in subdivision (cc) of Section 10112.1 of Title 8 of the California Code of Regulations, or loss control work for the insurance and financial service industries

  • Certain licensed physicians, surgeons, dentists, podiatrists, psychologists, or veterinarians

  • Certain licensed attorneys, architects, landscape architects, engineers, private investigators and accountants

  • Certain registered securities broker-dealers or investment advisers or their agents and representatives

  • Certain direct salespersons

  • Certain manufactured housing salespersons

  • Certain licensed commercial fishers (only through December 31, 2025 unless extended by the Legislature)

  • Certain newspaper distributors or carriers (only through December 31, 2024 unless extended by the Legislature) Certain persons engaged by an international exchange visitor program Certain competition judges

  • Certain home inspectors, as defined in Section 7195 of the Business and Professions Code, and subject to the provisions of Chapter 9.3 (commencing with Section 7195) of Division 3 of that code.

Occupations or contracting relationships where Labor Code sections 2775 et seq. requires that additional requirements must first be met in order to use the Borello test instead of the ABC test:

  • Certain professional services contracts for marketing representatives; human resources administration; travel agents; graphic design artists; grant writers; fine artists; enrolled agents licensed to practice before the IRS; payment processing agents; still photographers/ photojournalists; videographers; photo editors to a digital content aggregator; freelance writers, translators, editors, copy editors, illustrators, or newspaper cartoonists; content contributors, advisors, producers, narrators, or cartographers for a journal, book, periodical, evaluation, other publication or educational, academic, or instructional work in any format or media; licensed barbers, cosmetologists, electrologists, estheticians, or manicurists (manicurists only through December 31, 2024); specialized performing arts Master Class Instructors, appraisers, registered professional foresters, and data aggregators, as defined. Borello applies to determine whether the individual is an employee of the hiring entity if initial requirements are met.

  • Relationships between two individuals working on a single engagement event, defined as a stand-alone non-recurring event in a single location, or a series of events in the same location no more than once a week. Borello applies if initial requirements are met.

  • Certain individuals performing work under a subcontract in the construction industry, including construction trucking (with certain specific conditions applicable to construction trucking only through December 31, 2024). Borello and Labor Code section2750.5 apply to determine whether the individual is an employee of the contractor if initial requirements are met.

  • Certain service providers who are referred to customers through referral agencies to provide services including, but not limited to, graphic design, web design, photography, tutoring, consulting, youth sports coaching, caddying, wedding or event planning, services provided by wedding and event vendors, minor home repair, moving, errands, furniture assembly, animal services, dog walking, dog grooming, picture hanging, pool cleaning, yard cleanup, and interpreting. Borello applies to determine whether the service provider is an employee of the referral agency if initial requirements are met.

  • The following services are excluded: services provided in an industry designated as a high hazard industry, janitorial, delivery, courier, transportation, trucking, agricultural labor, retail, logging, in-home care, or construction services other than minor home repair.

  • Certain individuals performing services pursuant to a third party’s contract with a motor club to provide motor club services. Borello applies to determine whether the individual is an employee of the motor club if initial requirements are met.

  • Certain bona fide business-to-business contracting relationships. Borello applies to determine whether the business providing services is an employee of the business contracting for the services if initial requirements are met.

For two specific industries, special rules under Labor Code section 2778(b) require examination under the Business and Professions Code:

  • Certain real estate licensees, for whom the test of employee or independent contractor status is governed by section 10032(b) of the Business and Professions Code. (If that section is not applicable, then Borello is the applicable test for purposes of the Labor Code, except ABC will be the applicable test for purposes of workers’ compensation as of July 1, 2020.)

  • Certain repossession agencies, for which the determination of employee or independent contractor status is governed by Section 7500.2 of the Business and Professions Code.

What is the Borello Code?

Like the ABC Test, the Borello test assumes that all workers are employees and places the burden on the employer to show that the work meets the criteria to be considered an independent contractor. Unlike the ABC Test there is no specific set of standards that must be met with a clear delineation between employee and contractor. Instead the court would consider a multitude of factors, as listed below, in their entirety and will be based on the individual circumstances of each instance. This makes it less clear for both the worker and the employer. The factors being considered include:

  1. Whether the worker performing services holds themselves out as being engaged in an occupation or business distinct from that of the employer;

  2. Whether the work is a regular or integral part of the employer’s business;

  3. Whether the employer or the worker supplies the instrumentalities, tools, and the place for the worker doing the work;

  4. Whether the worker has invested in the business, such as in the equipment or materials required by their task;

  5. Whether the service provided requires a special skill;

  6. The kind of occupation, and whether the work is usually done under the direction of the employer or by a specialist without supervision;

  7. The worker’s opportunity for profit or loss depending on their managerial skill;

  8. The length of time for which the services are to be performed;

  9. The degree of permanence of the working relationship;

  10. The method of payment, whether by time or by the job;

  11. Whether the worker hires their own employees;

  12. Whether the employer has a right to fire at will or whether a termination gives rise to an action for breach of contract; and

  13. Whether or not the worker and the potential employer believe they are creating an employer-employee relationship (this may be relevant, but the legal determination of employment status is not based on whether the parties believe they have an employer-employee relationship).

What happens if employers misclassify workers as independent contractors?

Aside from potential penalties for wage violations, employers and HR professionals face the risk of civil penalties for deliberate misclassification. Labor Code section 226.8 outlines these penalties, ranging from $5,000 to $25,000 per violation, for willfully misclassifying individuals as independent contractors.

Willful misclassification includes intentionally and knowingly categorizing an employee as an independent contractor. However, companies might find it tempting to do so for several reasons, including:

  • Cost Savings: Independent contractors are typically not entitled to employee benefits, such as health insurance, paid time off, or retirement plan contributions. By classifying workers as independent contractors, employers may aim to avoid these extra costs associated with traditional employment relationships.

  • Flexibility: Unlike employees, independent contractors often have more flexibility in their work schedules and arrangements. Employers may misclassify workers to offer flexibility in scheduling and task assignments without the legal obligations and restrictions coming with traditional employment.

  • Simplified Payroll and Taxes: Contract work often creates room for more flexibility, but it also makes independent contractors responsible for their own taxes, meaning they're not subject to payroll tax deductions. As a result, employers may misclassify them to streamline payroll processes and minimize administrative burdens associated with tax withholding and reporting.

  • Avoiding Employment Laws: Various employment laws and regulations designed to protect employees, such as those covering overtime pay and safety standards, don't extend to independent contractors. This lack of coverage may incentivize employers to misclassify workers, enabling them to sidestep compliance with these regulations and mitigate legal liabilities.

Other risks companies face for misclassification include the potential for insufficient tax payments and the obligation to cover their employees' portion of payroll taxes, which could lead to penalties and accruing of interest.

The following scenarios make the independent contractor vs. employee classification easier to understand:

Jane works as a delivery driver for a local restaurant. She works long hours and is paid a flat rate without overtime. Although Jane's employer controls her schedule, tasks, and attire, he claims Jane is an independent contractor. Upon learning her rights, Jane realizes she's legally an employee entitled to minimum wage and overtime. After filing a claim with the Labor Commissioner, she receives back pay, and her employer faces penalties for violations such as failure to provide workers' compensation and pay employment taxes.

John is a marketing professional working for a local retail establishment. He performs work for the company in his own time and using his own equipment and resources. John also provides marketing services to several other businesses. According to the requirements of the ABC test John can be treated as an independent contractor. Let’s review: Part A, John controls when, where, and how he completes the work; Part B, the company does not regularly engage in or provide marketing services, and; Part C, John regularly provides marketing services to other businesses.

John; Marketing expert

How to keep up with Employment Laws in California

Legislature, regulations, and case law create an environment of constantly shifting and updating requirements. This can make it difficult for employers to maintain consistent and timely compliance.

Moving Mountains HR Consulting is here to ease that burden for employers. With years of expertise in regulatory compliance, risk management, and human resources Moving Mountains will stay on top of the Employment Laws so you can focus on your business.

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