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California AB-5 Law Dictates Gig Economy Workers Must Be Treated as Employees

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The gig economy has been on the rise for a while now, altering the way people find and perform an increasing number of jobs—from ride-sharing to delivering groceries to consulting on high-level projects.

And as the app-based and online technology that simplifies those transactions evolves—matching workers with the businesses and consumers who need their services—the trend is expected to continue.

But there have been growing pains. Some gig workers and their supporters have raised questions about basic protections and benefits they’ve lost out on because they’re considered independent contractors instead of employees, including overtime pay, paid sick days, and worker’s compensation insurance.

Others say the flexibility many independent workers enjoy can translate to job volatility for those who participate in what the US Bureau of Labor Statistics calls “electronically mediated employment ,” especially those who drive for a living.

Now it seems their voices were heard, at least in California, where a groundbreaking law signed by Governor Gavin Newsom in September went into effect January 1, 2020. The law is expected to change the way employers treat certain nontraditional workers, but it has seen a lot of push back from companies.

Assembly Bill 5, also known as AB-5, has been praised for its potential to change the way companies such as Uber, Lyft, and Instacart treat their drivers.

But those aren’t the only workers who are affected by the new law. Independent contractors in a broad range of professions saw changes.

Some are happy about it. Others were not. And because there could be a ripple effect across the country, employers and workers who rely on contract work in other states are watching is unfolding in California.

Here’s a quick guide to what AB-5 is meant to do and what it could mean in the future.

What Does AB-5 Do?

The new law codifies and grants exemptions to a 2018 California Supreme Court decision , Dynamex Operations West, Inc. v. Superior Court of Los Angeles County, which makes it more difficult for employers to classify workers as independent contractors.

The Dynamex decision acknowledges that in some circumstances, the independent contractor classification can be good for both workers and employers, but, it states, “In recent years, the relevant regulatory agencies of both the federal and state governments have declared that the misclassification of workers as independent contractors rather than employees is a very serious problem, depriving federal and state governments of billions of dollars in tax revenue and millions of workers of the labor law protections to which they are entitled.” AB-5 extended the decision to all California employment law.

Both the court’s decision and AB-5 use what’s referred to as an “ABC” test to determine if workers should be labeled employees. A worker is considered an independent contractor only if the hirer establishes all of the following:

  (A) The worker 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 such work and in fact;

  (B) The worker performs work that is outside the usual course of the hiring entity’s business; and

  (C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

Under the new law, more workers—from golf caddies to exotic dancers to some health-care providers—have become regular employees as of January 2020, with all the benefits mandated by the state.

What’s In It for California?

Besides improving the treatment of workers in the state, according to the State of California’s Department of Industrial Relations, misclassification results in an estimated $7 billion a year loss of payroll tax revenue and increased reliance on the public safety net.

Current Federal Guidelines for Determining Who Is an Independent Contractor

According to the IRS , businesses must weigh the following behavioral, financial, and relationship factors when deciding if a worker is an independent contractor or employee with regard to taxes:

•  Does the company control or have the right to control what the worker does and how the worker does his or her job?

•  Are the business aspects of the worker’s job controlled by the payer? (These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

•  Are there written contracts or employee-type benefits (e.g., pension plan, insurance, vacation pay)?

•  Will the relationship continue, and is the work performed a key aspect of the business?

If the choice remains unclear, a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, may be filed by either the business or the worker, and the IRS will determine the worker’s status.

There’s also a bill at the federal level, the NEW GIG Act of 2019 , which is still in committee. There’s no way to tell if the language will remain as it is now, but currently the bill establishes its own test for determining if a service provider should be classified as an independent contractor, rather than as an employee, for tax purposes.
Those factors include:

  (A) The relationship between the parties (i.e., the provider incurs expenses; does not work exclusively for a single recipient; performs the service for a particular amount of time, to achieve a specific result, or to complete a specific task; or is a sales person compensated primarily on a commission basis).

  (B) The place of business or ownership of the equipment (i.e., the provider has a principal place of business, does not work primarily at the recipient’s place of business, and provides tools or supplies).

  (C) The performance of the services under a written contract that meets certain requirements (i.e., specifies that the provider is not an employee, the recipient will satisfy withholding and reporting requirements, and that the provider is responsible for taxes on the compensation).

Issues with Switching Independent Contractors to Employees

To put it frankly, the decision usually comes down to money. Reclassification could cost big-gig companies plenty, as they’ll be required to pay minimum wage, overtime, and provide worker’s compensation coverage and other benefits to their many workers. reported in June (before the bill became law) that Barclays analysts estimate reclassifying workers could cost Uber and Lyft an additional $3,625 per driver in California, which could boost Uber’s annual operating loss by more than $500 million and Lyft’s by $290 million.

There’s also the potential that workers will become better organized and perhaps unionize. Drivers already have been self-organizing, with support from labor unions, and that effort could accelerate.

The new head of Brooklyn-based Freelancers Union, Rafael Espinal, is getting in on the conversation about AB-5 and proposed bills like it in other states. He would like to see that the organization “plays a vital role [in] the shaping of the legislation.”

Espinal resigned his Democratic councilman seat in Brooklyn, N.Y., and will officially take the executive director position of Freelancers Union March 2. In his tenure as councilman, Espinal was an advocate for New York City freelancers, co-sponsoring the Freelance Isn’t Free Act.

“Assembly Bill 5 is a landmark legislation for workers and our economy,” Gov. Newsom wrote in a letter to members of the California Assembly the day he signed AB-5. “A next step is creating pathways for more workers to form a union, collectively bargain to earn more, and have a stronger voice at work.”

Those who use the services and products provided by companies affected by AB-5 will have to wait and see if they pass down some of these costs to consumers. Several of the largest gig-platform companies are based in California, including Uber, Lyft, and DoorDash.

Examples of Exempted Work Scenarios Under AB-5

Exempted professions include doctors, lawyers, insurance agents, real estate agents, stockbrokers, accountants, hairstylists and aestheticians, marketing professionals, travel agents, fine artists, and commercial fishermen.

The law includes exemptions for certain types of work and payment arrangements, and, in the case of freelance photographers and writers, even provides exceptions based on the number of submissions accepted in a year (35) by a hypothetical employer.

Are All Affected Workers Happy About the New Law?

No. Some have voiced concerns about losing the flexibility that their independent status offered them. Others worry it will limit the amount of work they’ll be able to do.

Reaction to the change varies greatly, and is often based on a worker’s personal preference, hours, pay, good communication, and fair negotiations with an employer, and the ability to access and/or afford the types of benefits the law might provide (insurance, a retirement plan, etc.).

What’s Next?

Gov. Newsom has said that, moving forward, he remains open to compromise, and leaders from Uber and Lyft have voiced similar hopes.

The ride-share companies have already proposed a few changes to their relationship with drivers. Under the framework they suggest, drivers would remain independent contractors, but they would be able to receive an earnings guarantee and some benefits, along with a more effective way to communicate with management.

The companies also have said they would support a $21-an-hour minimum wage for drivers in California, but only when there’s a rider in the car or they’re on their way to pick up a passenger. (A 2018 study by the Economic Policy Institute found that Uber drivers took home the equivalent of $9.21 in hourly wages after accounting for fees, vehicle costs, health insurance, and other benefits that would be earned by traditional employees.)

At the same time, Uber says the new law doesn’t automatically apply to its drivers because their work is considered by Uber to be outside the usual course of Uber’s business, “which is serving as a technology platform for several different types of digital marketplaces.”

And Uber, Lyft, and DoorDash Inc. have announced they will each put $30 million toward a 2020 ballot initiative that would make changes to AB-5.

Other industries and individuals in California also can be expected to continue lobbying (or litigating) for exemption or inclusion, while others likely will be preparing for AB-5 compliance.

On a national level, Senator Bernie Sanders addresses worker misclassification and “exploitation” in his pro-union “Workplace Democracy Plan,” which is part of his 2020 campaign for president. He and several other Democratic presidential candidates support AB-5.

How Might AB-5 Impact Gig Economy Stocks?

Size matters, and according to the 2018 Freelancing in America study commissioned by Upwork and the Freelancers Union, more than 1 in 3 Americans freelanced last year, with growth especially strong among younger generations and full-time freelancers.

In its 2018 report The Gig Economy and Alternative Work Arrangements, Gallup found that 36% of US workers participate in the gig economy through either their primary or secondary jobs.

Many of the technologies and business practices that make the gig economy possible are still relatively new, and there will be growing pains. But entrepreneurs will likely continue to find ways to expand it, and consumers to grab on to what works.

Investors who want to get in on those opportunities—including beginning investors might want to start with buying into stocks or funds in sectors they’re enthusiastic about.

One thing to keep in mind, as you research any ETF is that any gig companies held in an ETF that go public have the possibility of being included in the portfolio when the IPO has traded for more than six months.

With pay and benefits potentially improving for many of its workers, the gig economy may be an appealing option for those who’d like to make investments based on their research and what they can feel good about.

Want to tap into the growth and innovation of the gig economy? Check out the new SoFi Gig Economy ETF.

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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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