California passes law stringently defining Independent Contractors after the Dynamex case

Last week California Governor Gavin Newsom signed a new legislation that codifies the test for determining when a worker is an independent contract as outlined in a California Supreme Court decision last year. This legislation, which goes into effect on January 1, 2020, is based on the stringent “ABC” test adopted by the California Supreme Court decision in Dynamex Operations West, Inc. v. Superior Court of Los Angeles case of 2018.

This legislation codifies that a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates that the person is free from the control and direction of the hiring entity in connection with the performance of the work, the person performs work that is outside the usual course of the hiring entity’s business, and the person is customarily engaged in an independently established trade, occupation, or business.

Under this new law, a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates that all of the following conditions are satisfied:

(A) The person 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.

(B) The person performs work that is outside the usual course of the hiring entity’s business.

(C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

As can be seen from the above, the new law lays down a very expansive definition of ‘employee’ by adopting the Dynamex case, whereby a worker is considered to be an independent contractor only if all three of the laid out factors are present.

The new legislation following the Dynamex ruling, marks a significant departure from the Borello multi-factor balancing test This could have far reaching impact on nearly every sector of the economy. The supporters of the legislation hail it as a landmark legislation to improve pay and benefits for low- and middle-wage workers, that could change the employment status of more than a million Californians including janitors, truckers, health care workers, construction workers, among others. This legislation would also cover gig economy workers such as software coders/ developers and other independent workers. The critics of the new legislation feel that the new classification test hampers the modern day employment models, especially in the Silicon Valley as it is out of tune with the flexibility and multiple freelance income opportunities that are available to independent software professionals.

Uber, Lyft and several other gig economy companies are finding ways to challenge the applicability of the tests on workers associated with them and are continuing with their lobbying campaign to keep them out of reach of the new legislation.

Exemptions

The following occupations have however, been provided exemption from the coverage of the new law and instead, the determination of employee or independent contractor status for individuals in those occupations shall be governed by Borello test.

(1) A person or organization who is licensed by the Department of Insurance

(2) A physician and surgeon, dentist, podiatrist, psychologist, or veterinarian licensed by the State of California

(3) An individual who holds an active license from the State of California and is practicing one of the following recognized professions: lawyer, architect, engineer, private investigator, or accountant.

(4) A securities broker-dealer or investment adviser or their agents and representatives

(5) Certain direct sales salesperson who perform services as a real estate, mineral, oil and gas, or cemetery broker or as a real estate, cemetery or direct sales salesperson, or a yacht broker or salesman.

(6) A commercial fisherman working on an American vessel

Severe criminal and civil penalties and fines

Employers not following the new law by mis-categorizing a worker as independent contractors, instead of as an employee could be subject to statutory fines and penalties under California Labor Code, EDD laws and California Franchise Tax board besides Internal Revenue Service as well.

Double Whammy for certain workers as well

Although the new law seems to be for the protection and benefit of workers by and large, as it provides them with employment law protection and benefits, for certain sales or field workers it may come as a disadvantage. This would be as as the JOBS Act 2017 removed the unreimbursed employment expense deduction for all employees. A lot of workers working purely on commission, cannot claim their legitimate travel, supplies, meals and many other out of pocket expenses if they are categorized as employees working on W2, but if they work as independent contractors, they could claim all such expenses while filing Schedule C for their tax returns as independent contractors.