State legislators in California recently passed a controversial new bill that requires many companies like Uber and Lyft, which rely primarily on independent contractors, to reclassify their contractors as employees. The bill, known as Assembly Bill 5 (AB 5), stands to upend the business model of the affected companies in California and potentially impact the nature of the worker-employer relationship at a national level as well.

The legislation, which was approved in the state Senate and sent to Governor Gavin Newsom, who has pledged his support, is expected to go into effect starting on January 1, 2020. AB 5 stands to impact at least one million workers, including not just ride-hailing drivers, but also those working in construction, food delivery, janitorial, nail salons, and various franchise operations.

AB 5 codifies a 2018 California Supreme Court decision that adopted a three-part standard for determining which workers should be treated as employees. Under the new standard, known as the “ABC test,” a worker is an employee if his or her job forms part of a company’s core business; if the employer directs the way the work is done; or if the worker has not established an independent trade or business.

Unlike contractors, workers classified as employees are entitled to benefits like minimum wage, overtime pay, sick leave, unemployment insurance, and workers’ compensation. Employers are also required to pay into an employee’s Social Security or Medicare taxes.

Requiring companies to offer such benefits to the majority of their workforce is expected to increase the labor costs of affected companies by up to 30%. And because these companies have built their entire operations around inexpensive, independent labor, it could force some companies out of business entirely.

Other states have adopted laws extending certain benefits such as minimum wage and unemployment insurance to contractors, but California’s new legislation completely changes the employment relationship. What’s more, it gives the state and cities the right to sue companies for misclassification, overriding arbitration clauses that many companies have used to protect themselves from worker complaints.

Lawmakers across the country have been closely monitoring AB 5, and the California law is likely to set a precedent for other states to follow. It could also be the catalyst for similar legislation at the federal level that’s now pending in Congress, and several Democratic presidential candidates have already endorsed AB 5. 

But businesses in California aren’t conceding defeat just yet. Uber, Lyft and DoorDash pledged $90 million to support a statewide ballot initiative for 2020 that would effectively exempt them from the legislation. And Uber’s legal team said they don’t intend to reclassify their workers, even after the law goes into effect. The company also plans to continue litigating misclassification claims in arbitration, as it has previously done. 

Thanks to intense lobbying from the California Chamber of Commerce and trade associations, a number of professions will be exempt from AB 5. Some of the most notable exempted occupations include physicians, dentists, veterinarians, psychologists, engineers, lawyers, accountants, architects, real estate agents, investment advisors, insurance brokers, hair stylists, barbers, and certain certain construction workers. 

The passage of AB 5 highlights the critical importance of correctly classifying your workers, as other state’s may hop on this bandwagon or begin to look at employee classification as a source of increasing state revenues from taxes. This applies not only to popular gig professions like ride-hailing and food delivery, but for all businesses that use independent contractors, including yours. It also makes it even more vital to have airtight independent contractor agreements in place for every contractor you hire, without exception, and to consider other safe harbor strategies.

If you’re a business owner in California and use independent contractors in your business, contact us right away to review your employment practices. We specialize in helping business owners stay in full compliance with constantly evolving employment laws. Whether you need assistance with worker classification, need new agreements created, want your existing agreements reviewed, or simply have questions about the current legal landscape, you can rely on us. 

We offer a complete spectrum of legal services for business owners and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer you a LIFT Your Life And Business Planning Session, which includes a review of all the legal, insurance, financial, and tax systems you need for your business. Schedule online today.