How to fortify your business against AB5 and beyond

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[Author: Scott Miller]

In early January, California truck drivers and transportation companies breathed a collective sigh of relief before going about their important business. That’s because Assembly Bill 5 (AB5), a law that makes it more difficult to classify workers as independent contractors (ICs), became subject to a preliminary injunction, freeing truckers from this restrictive piece of legislation—for now.

This decision and others like it will be debated in courts for years to come. And similar legislation is already taking shape—and becoming law—in states such as New Jersey, New York and Illinois. What does this mean for industries that rely on a 1099 workforce, also known as “gig” workers? It means nobody’s out of the woods yet.

The ABCs of AB5

A key part of AB5 is that it codifies the ABC test, a difficult-to-pass standard currently in use by the U.S. Department of Labor and at the agency level in more than 30 states. According to this test, the U.S. government classifies all workers as employees by default unless they meet the following three criteria:

  1. 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.
  2. The worker performs work that is outside the usual course of the hiring entity’s business.
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

Each contracting company must be able to prove all three criteria for every IC; otherwise, those workers become W-2 employees, which cost an average of 30% more than their 1099 counterparts along with requiring numerous operational and process changes. Failing to comply with this test can result in hefty fines, a sudden call for back taxes and benefits, and other penalties. But don’t panic yet. AB5’s business-to-business exemption helps formulate a path forward, no matter what part of the country you operate in.

Going business to business

AB5 exempts contracting companies engaged in a business-to-business relationship with ICs from the ABC test, if all 12 of the exemption criteria are met. To be sure, this is a narrow exemption as, if you’re in California, meeting the 12 criteria may necessitate changes significant changes to your processes. However, because these criteria define a true business-to-business model they also provide a best practice blueprint for contracting companies around the country to reduce their misclassification (not to mention third-party liability) risks and shore up their own workforce models ahead of pending legislation and increased adoption of more rigorous classification standards.

So what are these 12 key criteria? We break them down by what AB5 law says—and what lesson you should take away.

  The Law The Lesson
1 The business service provider is free from the control and direction of the contracting business entity in connection with the performance of the work, both under the contract for the performance of the work and in fact. The key phrase here are “free from control.” If your business provides direct supervision for ICs, pays hourly instead of per job, issues requirements on the performance of work, or exercises any other forms of direct control, you might be asking for trouble.
2 The business service provider is providing services directly to the contracting business rather than to customers of the contracting business. Another ambiguous one, which essentially means that all contracts and services should take place between the contracting business and IC. If the IC must work at the site of the contracting company’s customer, make every effort to ensure an arm’s-length relationship between the two. That includes day-to-day communication—ICs should not be receiving orders from your customers.
3 The contract with the business service provider is in writing. This one seems straightforward: You must formalize your business-to-business relationship in writing. Anyone who’s created, maintained and stored contracts, however, knows this process can be complex. Make sure you have a system in place (document management technology can help).
4 If the work is performed in a jurisdiction that requires the business service provider to have a business license or business tax registration, the business service provider has the required business license or business tax registration. As the contracting company, you must be able to prove that your ICs have their own business entity and employer identification number. This is best established upfront—get documentation before contracts are signed. While ensuring each IC has these can be challenging, there are solutions to make it easier for them.
5 The business service provider maintains a business location that is separate from the business or work location of the contracting business. Is the IC’s business address different from the contracting company’s? This is another self-explanatory rule that can be difficult to prove without proper documentation.
6 The business service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed. Is the service provided by the IC the same service they usually provide as their business? If so, this is a good indication of a legitimate business-to-business-relationship.
7 The business service provider contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring entity. Does the IC have other customers? If not, you may be running the risk of them being misclassified as an employee.
8 The business service provider advertises and holds itself out to the public as available to provide the same or similar services. Contracts must occur between legitimate businesses. Marketing materials such as business cards are a good way to show that the contractor is presenting itself to the public as an available commercial entity. Gathering proof of this during contractor onboarding is critical.
9 The business service provider provides its own tools, vehicles, and equipment to perform the services. An IC must provide their own “tools of the trade,” whether that means vehicles or power tools. If you are providing tools to ICs, you may be inadvertently acting as an employer in the eyes of the law.
10 The business service provider can negotiate its own rates. A contracting company must let ICs set their own rates without restriction. You must also provide evidence of negotiation or unique contract terms. Negotiations should be fully captured in writing during the onboarding process.
11 Consistent with the nature of the work, the business service provider can set its own hours and location of work. This doesn’t mean you can’t set deadlines. But it does mean you shouldn’t dictate where or when the IC works to meet those deadlines.
12 The business service provider is not performing the type of work for which a license from the Contractor’s State License Board is required, pursuant to Chapter 9 (commencing with Section 7000) of Division 3 of the Business and Professions Code. This guideline is specific to AB5 and California, and states that the business-to-business exemption does not apply to construction companies because there is already a construction subcontract exemption.

Whether you’re in California or not, by putting processes in place that meet these stipulations, you can establish best practices and document a true business-to-business model that can provide another defensive barrier against the standards and pending legislation in play across the U.S. and other  Remember, the burden of proof is on you, and these criteria require a lot of proof.

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