Small Business

How Does the New California Contractor Law Affect Small Businesses?

Published on January 28, 2020


If you’re a small business owner, the new California independent contractor law may impact your businesses and employees. The recently implemented law requires companies to follow significant new rules to determine if their workers are independent contractors or employees.

Continue reading to learn more about the new California contractor law and how it affects small business owners as well as gig economy workers.

What is the new California independent contractor law?

The new California independent contractor law, officially known as California Assembly Bill 5 (AB5), was signed into law by Governor Gavin Newsom in September 2019 and went into effect on January 1, 2020. Essentially, the law means that California companies must now classify independent contractors as employees, with certain exemptions and exceptions.

Codifying the California Supreme Court decision in the April 2018 Dynamex case, the California independent contractor law requires companies to use a specific three-part test, called the ABC test, to determine if their workers are employees or independent contractors.

What is the ABC test under the new California contractor law?

Used to determine employment classification, the ABC test considers a worker to be an employee and not an independent contractor, unless the hiring business can demonstrate all three of the following criteria, according to the California Department of Industrial Relations:

  • The worker is free from the direction and control of the hiring entity as they perform the work;
  • The worker does work that is outside of the hiring entity’s usual line of business; and
  • The worker must operate their own independently established business or trade.

As a result of AB5 and the ABC test, particular workers in California may no longer be considered independent contractors, even if they were formerly considered contractors under IRS guidelines.

How does the new California contractor law impact small business owners?

The California contractor law primarily affects small business owners in terms of their staffing and employment obligations, as well as cost-related questions about taxes, benefits, and legal compliance.

By using independent contractors instead of employees, employers typically do not have to pay Social Security and Medicare taxes, workers’ compensation, unemployment insurance, and disability insurance. Contractors also do not receive benefits such as health insurance or 401(k) contributions.

With the implementation of the new California independent contractor law, some small businesses may now have to hire contractors and reclassify them as employees in order to comply with the new legislation. Due to the resulting increase in labor costs, small businesses may need to reevaluate their staffing structure or potentially decide to no longer use independent contractors in California.

However, the California contractor law does not apply to all industries. Currently, AB5 has exemptions for over 50 types of businesses and professions, including lawyers, doctors, architects, real estate agents, and insurance agents; however, they must be able to choose their own work hours and determine their own fees.

How does the California contractor law affect gig economy workers?

Depending on the perspective and preferences of gig economy workers, the new California contractor law may provide both advantages and disadvantages.

On the one hand, with many independent contractors now reclassified as employees, these gig economy workers will now be able to enjoy the benefits previously only offered to regular employees.

On the other hand, many gig economy workers prefer the flexibility of being able to set their own hours and work independently for a variety of companies and clients. Former contractors reclassified as employees under the new law may lose the ability to set their own schedules, which is one most appealing reasons for taking a gig economy job.

What should small business owners do to comply with the California independent contractor law?

First, small business owners should work with their legal advisors in order to make sure they are compliant with the new law, and to avoid financial penalties for misclassifying employees as contractors.

  • Businesses may want to consider reviewing their current independent contractor agreements to make sure that the contracts clearly define their legal relationship with their contractors.
  • Ways to clarify this independent legal relationship include using contractors who work with multiple clients, have their own independently established businesses, and provide evidence of paying for their own taxes and insurance.

Overall, compliance with the California contractor law may continue to evolve over time, as more businesses adapt to the new rules, and particular industries and professions seek additional exemptions.

Ultimately, the new California independent contractor law is a significant change in the state’s employment regulations, which will require many small business owners to make challenging decisions about how their businesses can effectively comply with the recently enacted legislation.

This article is for general information and may not be updated after publication. Consult your own tax, accounting, or legal advisor instead of relying on this article as tax, accounting, or legal advice.

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