There’s a new California law that will make it harder for companies to classify workers as independent contractors. It took effect January 1, 2020. This will affect many digital web and marketing agencies throughout the state. That is to say the law will put many tough restrictions on how a freelancer / independent contractor is classified.
Understanding the Law
Governor Newson signed the bill into law on September 18, 2019. The legislature referred to the bill as AB 5. They intended it to protect the “rights” of workers deemed non-employees. The State of California loses billions in tax revenue each year. This is because it can’t account for many workers as part of the employee tax base. The catch with this law is the burden of proof is solely on the employer. The company must prove that the worker in question passes certain criteria. If this is done, the government will consider the worker an independent contractor.
The Three Part Test
The law specifies a test to determine if a worker is an employee or an independent contractor. The regulation separates the test into three parts. The company must establish that the worker meets all three of these parts. If the company does this, the government will consider him or her a legitimate contractor:
First is Part A: Is the worker free from the control and direction of the hiring entity in the performance of the work, both under the contract for the performance of the work and in fact?
Second is Part B: Does the worker perform work that is outside the usual course of the hiring entity’s business?
Third is Part C: Is the worker customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity?
Companies like Lyft or Uber have a substantial budget to battle the State of California. So for them, these regulations will be a lot less intrusive. The case Uber and Lyft are making is they are not transportation companies. Therefore, the contractor in question is “performing work outside hiring entity’s business” (Part B). According to Tony West, Uber’s chief legal officer, “Just because the test is hard does not mean we will not be able to pass it,”
The legislation could cause difficulties for a small to a mid-level digital marketing agency. This is especially the case for satisfying “Part B”. A reasonable person might assume that marketing agencies’ usual “course of business” is not primarily web design & development. The catch is when the agency website lists those as offered services. In that case, claims can be made that design and development is part of the agency’s usual course of business. It will be hard to negate that claim.
Considerations for Specific Kinds of Contractors
Some independent contractors are exempt from the new law. There is a less stringent list of rules which qualify them for exemption according to the National Law Review website. Contractors in areas such as marketing, human resources, graphic design, and freelance photography, writing, and editing may qualify. A friendlier six-part test identifies exempt independent contractors:
- Maintain a separate business location (which can be their home);
- Have a business license in addition to any required professional licenses;
- Have the ability to set or negotiate their own rates;
- Set their own hours (other than project completion deadlines)
- Customarily engage in the same kind of work with another entity or holds themselves out to other potential customers for the same kind of work;
- Customarily and regularly exercises discretion and independent judgment in the work.
Modifying the Relationship with Your Independent Contractors
Your agency may still plan to use independent contractors. If so, it will be important to make sure that the elements of “Part A” & “Part C” are being satisfied. These two parts will require a modification/ clarification of your relationship with your worker. To a lesser extent, you may have to modify your agency’s overall business model.
Free from Control & Direction
Part A (free from control & direction) is important. You should establish within your contractor agreement that all contractors work with limited control and direction. Consequently, you should make sure to document this well in your contractor agreement. Most readers of this blog will be concerned with web development projects. These kind of contractor agreements would allow the contractor to do work at his or her discretion. This one can be a little tricky to satisfy when contractors are doing work on behalf of an agency. This is because the agency may have directions and requirements required to satisfy the needs of their end clients.
Work Being Performed Outside the Hiring Entity’s Business
Part B (work being performed outside the hiring entity’s business) Is another requirement that can be very tricky to satisfy. For example, a law firm may need to hire a carpenter. A very good case can be made that the normal “hiring entity’s business” is not carpentry. In another example, a marketing agency might list web design or development as offered services on the agency’s website. Examiners could interpret those services as a part of the “hiring entity’s business” model. A single aspect to complete a project might not be one of the services offered by an agency. So, this would be an example of an exception to Part B.
Worker Customarily Engaged independently
Part C (Is the worker customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity?) This part will be the easier of the three parts to establish. The key here is to make sure the contractor has multiple clients along with a business license.
Using Freelance Websites to Circumvent the Law
The biggest of the freelance websites is Upwork.com. I chatted with them looking for an answer to the possibility of using them to bypass the AB 5 law. The response I got was “Thanks for reaching out. Unfortunately, we cannot provide tax advice, please consult with a trusted tax advisor. If you need help classifying those you hire on Upwork, please let us know. We have several different compliance options and will be happy to help!”. Upwork would probably love to be able to claim that their service provides protection. However, they are not willing or are unable to under their current interpretation of the law.
The AB-5 law makes using contractors very tricky for web design and marketing agencies. An agency may plan to continue to use contractors as part of their workforce. If so, they should engage an attorney knowledgeable in the field of labor law. Defending yourself against a claim by the state of California will be costly to your agency. The way the law is written it is very difficult to defend against.
There are legal options for web design, web development, and/or digital marketing. Feel free to contact me with any questions you have. I was born and raised in California but have current residency in the state of Texas.