California’s so-called “Gig Worker Bill,” Assembly Bill 5 (AB 5), goes into effect on January 1, 2020. AB 5 modifies how workers are classified as employees or independent contractors for state law purposes and codifies the 2018 California Supreme Court decision known as Dynamex.
Nonprofits that make use of independent contractors should always pay special attention to the proper classification of workers as employees or independent contractors under both federal tax laws and state labor laws. Such classification is not merely a function of the parties’ intent. Largely to protect workers from being exploited by hiring parties, complex legal definitions codified in laws, regulations, and court opinions control. This has long been a major compliance issue and risk factor for many nonprofits. And it’s made more difficult because the definitions under federal and state laws differ.
From a federal tax perspective, an employer that misclassifies an individual who falls within the definition of an employee as an independent contractor may be failing to (1) contribute the employer’s share of payroll taxes and (2) properly withhold and forward to the IRS applicable payroll taxes. Such violations of tax law are regularly considered one of the IRS’s target areas for examination and audit, and the board members of a nonprofit employer may in certain instances be held personally liable for such violations.
From a state labor and insurance law perspective, an employer that misclassifies an individual who falls within the definition of an employee as an independent contractor may be failing to provide such individual with (1) wage and hour law protections accorded to employees, (2) workers compensation insurance coverage, and (3) unemployment benefits.
AB 5 – Excerpts from the Legislative Digest
AB 5 would provide that for purposes of the provisions of the Labor Code, the Unemployment Insurance Code, and the wage orders of the Industrial Welfare Commission, 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.
These exempt occupations would include, among others, licensed insurance agents, certain licensed health care professionals, registered securities broker-dealers or investment advisers, direct sales salespersons, real estate licensees, commercial fishermen, workers providing licensed barber or cosmetology services, and others performing work under a contract for professional services, with another business entity, or pursuant to a subcontract in the construction industry.
This bill would also redefine the definition of “employee” described above, for purposes of unemployment insurance provisions, to include an individual providing labor or services for remuneration who has the status of an employee rather than an independent contractor, unless the hiring entity demonstrates that the individual meets all of specified conditions, including that the individual performs work that is outside the usual course of the hiring entity’s business.
AB 5 – The ABC Test
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.Cal. Lab. Code §2750.3(a)(1)
With respect to meeting condition (A), a hiring entity must establish that it had no right to control the worker and not merely that it did not exercise control over the worker.
With respect to meeting condition (B), perhaps the one of greatest concern to many hiring entities, a hiring entity must establish that work in its usual course of business is different from the worker’s work performed for the hiring entity. Accordingly, a nonprofit documentary film production company would meet condition (B) if it hired a plumber but probably not if it hired a writer. This condition also may create a problem for franchisors, nonprofit organizations with affiliated chapters, and central organizations for subordinate organizations operating under a group exemption, if it is ultimately determined that they may also fall under the ABC Test with respect to their franchisees, chapters, and subordinate organizations’ workers, respectively.
With respect to meeting condition (C), a hiring entity must establish that the worker independently established a business providing substantially similar services to other parties. No longer is this simply a factor under the ABC Test (as it is in the Borello Test described below), it’s a required condition.
The Alternative Borello Test
According to the website of the California Department of Industrial Relations:
“For most matters before the Division of Labor Standards Enforcement (DLSE), depending on the remedial nature of the legislation at issue, this means applying the “multi-factor” or the “economic realities” test adopted by the California Supreme Court in the case of S. G. Borello & Sons, Inc. v Dept. of Industrial Relations (1989) 48 Cal.3d 341. In applying the economic realities test, the most significant factor to be considered is whether the person to whom service is rendered (the employer or principal) has control or the right to control the worker both as to the work done and the manner and means in which it is performed. Additional factors that may be considered depending on the issue involved are:
- Whether the person performing services is engaged in an occupation or business distinct from that of the principal;
- Whether or not the work is a part of the regular business of the principal or alleged employer;
- Whether the principal or the worker supplies the instrumentalities, tools, and the place for the person doing the work;
- The alleged employee’s investment in the equipment or materials required by his or her task or his or her employment of helpers;
- Whether the service rendered requires a special skill;
- The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the principal or by a specialist without supervision;
- The alleged employee’s opportunity for profit or loss depending on his or her managerial skill;
- The length of time for which the services are to be performed;
- The degree of permanence of the working relationship;
- The method of payment, whether by time or by the job; and
- Whether or not the parties believe they are creating an employer-employee relationship may have some bearing on the question, but is not determinative since this is a question of law based on objective tests.”
When the Borello Test is Used Instead of the ABC Test
Professional Services Exception
AB 5 provides that the ABC Test does not apply to a contract for “professional services” as defined below, and instead the determination of whether the individual is an employee or independent contractor will be governed by the Borello Test if the hiring entity demonstrates that all of the following factors are satisfied:
(A) The individual maintains a business location, which may include the individual’s residence, that is separate from the hiring entity. Nothing in this subdivision prohibits an individual from choosing to perform services at the location of the hiring entity.
(B) If work is performed more than six months after the effective date of this section, the individual has a business license, in addition to any required professional licenses or permits for the individual to practice in their profession.
(C) The individual has the ability to set or negotiate their own rates for the services performed.
(D) Outside of project completion dates and reasonable business hours, the individual has the ability to set the individual’s own hours.
(E) The individual is customarily engaged in the same type of work performed under contract with another hiring entity or holds themselves out to other potential customers as available to perform the same type of work.
(F) The individual customarily and regularly exercises discretion and independent judgment in the performance of the services.
“Professional services” means services that meet any of the following:
(i) Marketing, provided that the contracted work is original and creative in character and the result of which depends primarily on the invention, imagination, or talent of the employee or work that is an essential part of or necessarily incident to any of the contracted work.
(ii) Administrator of human resources, provided that the contracted work is predominantly intellectual and varied in character and is of such character that the output produced or the result accomplished cannot be standardized in relation to a given period of time.
(iii) Travel agent services provided by either of the following: (I) a person regulated by the Attorney General under Article 2.6 (commencing with Section 17550) of Chapter 1 of Part 3 of Division 7 of the Business and Professions Code, or (II) an individual who is a seller of travel within the meaning of subdivision (a) of Section 17550.1 of the Business and Professions Code and who is exempt from the registration under subdivision (g) of Section 17550.20 of the Business and Professions Code.
(iv) Graphic design.
(v) Grant writer.
(vi) Fine artist.
(vii) Services provided by an enrolled agent who is licensed by the United States Department of the Treasury to practice before the Internal Revenue Service pursuant to Part 10 of Subtitle A of Title 31 of the Code of Federal Regulations.
(viii) Payment processing agent through an independent sales organization.
(ix) Services provided by a still photographer or photojournalist who do not license content submissions to the putative employer more than 35 times per year. This clause is not applicable to an individual who works on motion pictures, which includes, but is not limited to, projects produced for theatrical, television, internet streaming for any device, commercial productions, broadcast news, music videos, and live shows, whether distributed live or recorded for later broadcast, regardless of the distribution platform. For purposes of this clause a “submission” is one or more items or forms of content produced by a still photographer or photojournalist that: (I) pertains to a specific event or specific subject; (II) is provided for in a contract that defines the scope of the work; and (III) is accepted by and licensed to the publication or stock photography company and published or posted. Nothing in this section shall prevent a photographer or artist from displaying their work product for sale.
(x) Services provided by a freelance writer, editor, or newspaper cartoonist who does not provide content submissions to the putative employer more than 35 times per year. Items of content produced on a recurring basis related to a general topic shall be considered separate submissions for purposes of calculating the 35 times per year. For purposes of this clause, a “submission” is one or more items or forms of content by a freelance journalist that: (I) pertains to a specific event or topic; (II) is provided for in a contract that defines the scope of the work; (III) is accepted by the publication or company and published or posted for sale.
(xi) Services provided by a licensed esthetician, licensed electrologist, licensed manicurist, licensed barber, or licensed cosmetologist provided that the individual:
(I) Sets their own rates, processes their own payments, and is paid directly by clients.
(II) Sets their own hours of work and has sole discretion to decide the number of clients and which clients for whom they will provide services.
(III) Has their own book of business and schedules their own appointments.
(IV) Maintains their own business license for the services offered to clients.
(V) If the individual is performing services at the location of the hiring entity, then the individual issues a Form 1099 to the salon or business owner from which they rent their business space.
(VI) This subdivision shall become inoperative, with respect to licensed manicurists, on January 1, 2022.
How “professional services” is defined to provide exceptions to different classes of businesses seems problematic and one that will require future clean up bills and more detailed regulations. For example, what distinguishes a “grant writer” from “fundraising counsel” (as defined in the Government Code)? And aren’t the exceptions more the result of strong lobbying efforts rather than equitable considerations?
The exception for “fine artist” also raises questions. What is a fine artist? Are definitions in the Civil Code applicable here? In Civil Code Section 987, fine art is defined as “an original painting, sculpture, or drawing, or an original work of art in glass, of recognized quality, but shall not include work prepared under contract for commercial use by its purchaser” and an artist is defined as “the individual or individuals who create fine art.” Also, why would other artists who may not be considered fine artists (e.g., performance artists) be excluded from the exception? The legislative analyses does not appear to address these questions. Could regulations be promulgated to broaden the Civil Code’s definition?
The ABC Test also does not apply to a bona fide business-to-business contracting relationship as described below:
If a business entity formed as a sole proprietorship, partnership, limited liability company, limited liability partnership, or corporation (“business service provider”) contracts to provide services to another such business (“contracting business”), the determination of employee or independent contractor status of the business services provider shall be governed by the Borello Test, if the contracting business demonstrates that all of the following criteria are satisfied:
(A) The business service provider is free from the control and direction of the contracting business entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
(B) The business service provider is providing services directly to the contracting business rather than to customers of the contracting business.
(C) The contract with the business service provider is in writing.
(D) If the work is performed in a jurisdiction that requires the business service provider to have a business license or business tax registration, the business service provider has the required business license or business tax registration.
(E) The business service provider maintains a business location that is separate from the business or work location of the contracting business.
(F) The business service provider is customarily engaged in an independently established business of the same nature as that involved in the work performed.
(G) The business service provider actually contracts with other businesses to provide the same or similar services and maintains a clientele without restrictions from the hiring entity.
(H) The business service provider advertises and holds itself out to the public as available to provide the same or similar services.
(I) The business service provider provides its own tools, vehicles, and equipment to perform the services.
(J) The business service provider can negotiate its own rates.
(K) Consistent with the nature of the work, the business service provider can set its own hours and location of work.
(L) The business service provider is not performing the type of work for which a license from the Contractor’s State License Board is required, pursuant to Chapter 9 (commencing with Section 7000) of Division 3 of the Business and Professions Code.
In some cases, it may be advantageous for a grantmaker to identify an individual grantee that is not a legal business entity as a sole proprietorship, which is listed as an acceptable form of business entity for purposes of the business-to-business exception described above. However, criteria (B) above may be problematic as a grantmaker would not want to assert that the business service provider is providing services directly to the contracting business. But neither is the business service provider providing services to customers of the contracting business. It’s simply a criteria that shouldn’t come into play if there is a grantmaker-grantee exception where the grants are exclusively to advance a 501(c)(3) – 23701d exempt purpose.
The IRS Form 1099-MISC is used to report certain miscellaneous income paid to persons, including at least $600 in:
- Services performed by someone who is not your employee (including parts and materials);
- Prizes and awards (that are not for services performed);
- Other income payments (including payment to independent contractors and prizes and awards for services performed as a nonemployee).
The Form 1099-MISC is often used by grantmakers in reporting certain grants to individuals, including where such grants are used in part by the grantees to pay for their necessary living expenses to allow them to dedicate their time and energies to complete the charitable grant purposes, which are intended to benefit the broader public and not specifically the grantmaker. The grantmaker does not own or control the charitable program it is funding or take any responsibility over the associated activities. However, the grantmaker generally takes steps to ensure the funds it granted were used in furtherance of the charitable grant purposes and not diverted for noncharitable purposes. This is very common in the area of Preapproved Grant Relationship (Model C) Fiscal Sponsorship in funding art projects.
It seems that a grant to an individual which must be used in furtherance of charitable purposes would generally be included in Box 3 of Form 1099-MISC and not in Box 7, where a hiring entity would typically report compensation to a non-employee independent contractor. Accordingly, it seems possible that identifying an individual’s compensation in Box 7 could raise more issue about whether a grantee is possibly an employee rather than a grantee. This would be a matter a nonprofit should check carefully with a knowledgable accountant or tax advisor.