Employee vs. Independent Contractor – it’s getting interesting in California

Over the years in my tax practice, one common question that keeps coming up is whether a worker should be treated as an independent contractor or as an employee. The answer to that question is quickly evolving in California. For many years the rules for determining worker status were the same for federal and California. But last year, thanks to a decision in the California Supreme Court, that changed.

Under the old rules numerous factors were evaluated to determine whether someone was an employee or an independent contractor. The Supreme Court case decided last year used a 3 part test sometimes called the ABC test to determine the proper classification of workers. The 3 part test is more restrictive than the multi-factor test. The main difference is that in the ABC test you are presumed to be an employee unless you meet all 3 of the tests. The biggest difference in the two approaches is that the 2nd test of the 3 is that anyone hired to do a core function in your business must be an employee. As an example, if Big Trucking Company hires a truck driver, he must be an employee since he is involved in the core function of the business. On the other hand, if Big Trucking hires someone to fix the office copy machine, that worker could be deemed an independent contractor since repairing copy machines is not a core function in a trucking company.

Last years Supreme Court case only applied to wage claims so for regular employment tax purposes, California still evaluated workers based on the multi-factor test, but wage claims (handled by the Department of Industrial Relations) used the ABC test to determine the correct worker status. Last week I attended a payroll tax seminar sponsored by EDD and DIR and the representatives of both agencies confirmed that they were using different methods to determine worker classification.

However, that was last week. Also last week the California legislature passed AB 5. On Wednesday of this week Governor Newsom signed this law which makes the ABC test mandatory for all California employers unless they meet one of numerous exceptions enumerated in the law. Most of this law takes effect on January 1, 2020 so many independent contractors in California will need to be reclassified as employees to comply with this new law.

If you are a California employer, I urge you to meet with your tax professional to determine if you need to make any changes for your workers. The full text of AB 5 can be found here. We would be happy to answer any questions you may have regarding how this new law will impact your business in California.