California Assembly Bill 5, the hard-fought bill that may one day give full employee status to workers engaged in the gig economy, has finally been signed into law by the office of California Governor Gavin Newsom.

The new law “will help reduce worker misclassification — workers being wrongly classified as ‘independent contractors’ rather than employees, which erodes basic worker protections like the minimum wage, paid sick days and health insurance benefits,” Newsom wrote in a signing message released by his office. 

Assembly Bill 5 is expected to have wide-reaching implications that resonate across the country— including posing an existential crisis for businesses built with independent, on-demand labor— as well as major tax implications.

What is Assembly Bill 5 (AB 5)?

Under AB 5, which will take effect January 1, 2020, Californians will be considered to be employees of a business unless an employer can show the work they perform meets a detailed set of criteria called the “ABC test” established by a California Supreme Court ruling last year. Under those criteria, a worker is an employee if his or her job forms part of a company’s core business, if the bosses direct the way the work is done or if the worker has not established an independent trade or business.

Under the new law, California workers could generally only be considered independent contractors if the work they do is outside the usual course of a company’s business. Conversely, workers must be employees instead of contractors if a company exerts control over how they perform their tasks, or if their work is part of a company’s regular business.

What’s changing with the passing of AB5?

Millions of workers are classified as independent contractors and don’t qualify for protections under the Fair Labor Standards Act, Americans with Disabilities Act or the Civil Rights Act. They also aren’t guaranteed other rights afforded to employees including minimum wage, overtime pay, or unemployment insurance. Now, for many, and especially those working in the tech sector, this will all change.

While this could be a big win for workers, the enactment of AB 5 could threaten the future of the gig economy that was built on contracted, on-demand labor. Many tech companies, including Uber and Lyft, which have been among the most vocal opponents, will have to rework their core business models. They stand to lose billions in the process and have threatened to pass those costs onto consumers.

Tax Considerations of AB5

AB 5 also changes the definition of “employee” (to the ABC test articulated in Dynamex) for purposes of the California Unemployment Insurance Code (the “CUIC”), which has important tax consequences. 

The CUIC contains the income and employment tax withholding requirements that apply to compensation paid to employees who are providing services in California. As a result, AB 5 may require employers in California to withhold (and remit) income and employment taxes with respect to compensation paid to workers who are deemed to be employees as a result of AB 5.  

Employers could, therefore, find themselves in the unusual position of having to withhold California income and employment for workers (because they are employees pursuant to the ABC test), but not having to withhold federal income or employment taxes with respect to these same workers (because they may continue to be treated as independent contractors under federal law).  We anticipate the California Employment Development Department will issue guidance in the near future as to how this somewhat bizarre situation should be handled.

Our experienced team at LGSH LLP is here to help you navigate the ever-changing California legislation that can impact how you and your clients do business. Call us today at 818-783-0570.