ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – AB5 – THE IMPORTANCE OF A WRITTEN CONTRACT
By Robert S. Schriebman
Time waits for no man. Currently, the EDD is conducting audits that begin midway through 2019 and conclude midway through 2022. Starting January 1, 2023, all standard EDD audits will begin with year 2020. January 1, 2020 is the effective date of AB5 and AB2257. The new ABC Test will apply. AB2257 modified and amended AB5 to include many exemptions but focused primarily on exemptions for the entertainment industry. As I reviewed AB2257 in preparation of this article I was once again struck by the emphasis on the requirement for written contracts for all exemptions. If the specific exemption did not set forth the requirement for a written contract its language makes reference to a contract between the parties. Virtually every exemption is going to require a written contract between the parties if an employer claims he/she is exempt under the new laws.
Not all written contracts are created equal. The written contracts that stand a chance with the EDD must have specific provisions requiring the independent contractor to be responsible for state and federal tax compliance. The contract must clearly state that the contractor file income tax returns and pay quarterly estimated taxes as well as withhold payroll taxes from any workers deemed to be employees. I cannot count how many written contracts I have reviewed, drafted by experienced attorneys, who fail to put in these vital provisions.
An Overview of AB2257
AB2257 has added many new provisions to the labor code. Most of these provisions set forth exemptions from the ABC Test, but not the Borello test. Perhaps the most popular provision will be section 2776, the so-called business-to-business exemption. This provision clearly requires the existence of a written contract between the parties. Section 2777, the referral agency, service provider exemption requires both a business license and a written contract between the parties. (See Subsection (b) 3 A & B). Section 2778, clearly applies to a “contract for professional services.” Every exemption either requires that the parties have a written contract between them or makes reference to the existence of a contract. No contract – no exemption. I think you get the idea
EDD Audits After January 2023
If I had a crystal ball and could predict the future of EDD audits, I would not see a radical change in how auditors do business. They’ll ask for the usual documentation, but the request will also include copies of business licenses and written contracts between the employer under examination and third-party independent contractors. Employers under audit, and their representatives, will take the position that the ABC Test does not apply because of an exemption listed under AB2257. The auditor will then demand the production of a written contract and a business license where required. If the employer cannot produce either or both documents, the auditor will apply the ABC Test and issue an assessment that most likely will include a negligence penalty assess pursuant to CUIC § 1127 – that’s a 15% penalty! For the EDD auditor new assessments are going to be a slam dunk. It is too early to tale what the impact will be on the settlement process if there is no written contract and/or license. For judges, they will have no choice but to rule against the employer due to the absence of these key documents.
Conclusion – Will the EDD Honor a Written Contract Pursuant to AB5 and AB2257?
Have you ever heard the saying, “Everything old is new again?” This may well apply to the impact a written contract will have on your EDD auditor. I cannot count how many well written contracts have crossed my desk when handling EDD audits. But I can almost count on my fingers how many were recognized as acceptable by the assigned auditor who concluded that there was a true independent contractor relationship – darn few! I can foresee auditors being trained to find inadequacies in future contracts that will allow them not to recognize an exemption and accordingly issue an assessment showing that the employer failed to get around the ABC Test. In other words, an employer’s written contract will not be legally sufficient in the eyes of the EDD for avoiding the ABC Test. Only time will tell. The future arguments will center around the adequacy of the written contract.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD, and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Web Site Article 676