What is California AB 5? Complete Contractor Classification Guide for Small Businesses
Running a small business in California is like navigating a maze of regulations. One wrong turn, like misclassifying a worker, can lead to costly penalties or legal trouble. California AB 5, enacted in 2019, reshapes how businesses classify workers as employees or independent contractors, impacting your payroll, taxes, and compliance. This guide simplifies contractor classification for small business owners, offering a clear path to compliance. We’ll break down AB 5, who it affects, and the small business compliance steps you need—plus answer common questions to keep you ahead. Table of Contents What is California AB 5? California AB 5, signed into law in September 2019 and effective January 1, 2020, is a landmark labor law aimed at reducing worker misclassification. It codifies the “ABC test” from the 2018 California Supreme Court case Dynamex Operations West, Inc. v. Superior Court, making it harder to classify workers as independent contractors. AB 5 applies to California’s Labor Code, Unemployment Insurance Code, and Industrial Welfare Commission wage orders, ensuring workers receive protections like minimum wage, overtime, and benefits. In 2020, AB 2257 amended AB 5, adding exemptions and clarifications, now codified in Labor Code sections 2775–2787. The ABC test presumes workers are employees unless the hiring business proves all three criteria: A UC Berkeley study estimated 64% of workers doing independent contracting as their main job would be reclassified as employees under the ABC test. This shift increased employee protections but reduced self-employment by 10.5% and overall employment by 4.4% in non-exempt occupations, with no significant rise in W-2 employment. AB 5 protects workers and levels the playing field for businesses that properly classify employees, but it’s complex. Small businesses must understand its rules to avoid fines, which range from $5,000–$25,000 per violation for misclassification. Who is Affected by AB 5? AB 5 impacts small businesses across industries, especially those relying on freelancers or gig workers, like retail, hospitality, construction, and trucking. If you hire contractors in California or work with California-based freelancers, you’re affected, even if your business is elsewhere. Key Impacts: Exemptions: AB 2257 expanded exemptions to 109 professions, but exempt workers must still pass the Borello test, which considers factors like control, tools provided, and work duration. A U.S. Department of Labor study found 10–30% of employers misclassify workers, a persistent issue AB 5 aims to address. Implications for Small Businesses California AB 5 reshapes how small businesses operate, presenting challenges that can feel like dead ends in the compliance maze. Understanding its implications helps you navigate these hurdles and stay on track. To avoid these pitfalls, assess your current contractor classification practices now. Review worker roles, check for exemptions, and consult legal experts to ensure compliance. Taking these steps protects your business and keeps you competitive. Key Compliance Needs for AB 5 Complying with California AB 5 means understanding the ABC test, exemptions, and your workers’ roles. Small businesses face legal and financial risks if they misclassify workers, so proactive small business compliance is critical. Core Compliance Needs: Why It Matters: California loses over $7 billion annually to misclassified workers, missing out on taxes and benefits contributions. Proper classification ensures compliance and fair competition. 5 Steps to Comply with AB 5 Follow these five steps to ensure your small business complies with California AB 5 and avoids costly mistakes. Each step is designed for small business compliance with practical examples. Step 1: Audit Your Workers Review all contractors to determine if they pass the ABC test. For example, if your café hires a freelancer to redesign your website, they likely pass “B” (outside your core business of serving food). A barista, however, fails “B” and must be an employee. Use a checklist for A, B, and C criteria. Step 2: Check for Exemptions Identify if your contractors fall under exemptions (e.g., B2B, freelance writers). For B2B, ensure the contractor has a separate business entity, sets their own rates, and doesn’t work directly for your customers. For exempt workers, classification is assessed using the Borello test, a multi-factor standard; consult an attorney to verify eligibility. Step 3: Update Contracts Draft AB 5-compliant contracts emphasizing contractor independence. Specify they control their work, use their own tools, and serve other clients. For example, a photographer’s contract should note they set their schedule and provide their camera. Keep invoices and agreements for audits. Step 4: Reclassify if Needed If a contractor fails the ABC test and isn’t exempt, reclassify them as an employee. Register them with California’s Employment Development Department for taxes and workers’ compensation. Provide benefits like 10-minute rest breaks per four hours and 30-minute meal breaks per five hours. Step 5: Monitor and Consult Regularly review worker classifications as your business or laws change (e.g., AB 2257 updates). Engage an employment attorney to stay compliant, especially for complex cases like trucking or healthcare. Schedule annual audits to catch errors early. Common Questions About AB 5 Compliance Small business owners often have questions about navigating California AB 5. Below, we answer common concerns to help you understand contractor classification and stay compliant. How Can I Use B2B Exemptions? Many small businesses hire contractors for tasks like marketing or IT and wonder if they qualify for the B2B exemption. To use it, your contractor must meet 12 criteria, such as operating as a corporation or LLC, having a separate business location, and signing a written contract. These rules allow flexibility while ensuring compliance. What Documentation Protects Me During Audits? You might worry about proving contractor status if audited. Clear contracts that specify a worker’s independence—such as setting their own hours and serving other clients—are essential. Keep invoices, work agreements, and proof of their independent business (e.g., business license). These records can prevent costly misclassification claims. How Does Proposition 22 Affect My Business? Proposition 22, passed in 2020 and upheld in 2023, classifies app-based transportation and delivery drivers as independent contractors, exempting them from AB 5. However, it mandates certain benefits, such as minimum earnings guarantees and health insurance stipends for qualifying drivers. How Can I Avoid
