Ask The California Employment Tax And Payroll Tax Attorney – The Immediate Impact Of AB 5 And Some Suggestions On How To Deal With The New Law
By Robert S. Schriebman
AB 5, the sweeping new legislation designed to convert independent contractors to W2 wage earners, is beginning to have affect on both the EDD and the prospective employers. This article will look at the immediate impact of AB 5and give you a few tips on how to deal with this new legislation, whether you are planning to convert all workers to employees or you wish to remain an independent contractor.
Impact of AB 5 on the EDD
AB 5 has given the EDD a huge arsenal of weapons for reclassifying independent contractors as W2 wage earners. In mid-December 2019 the EDD published and sent to employers throughout the state a letter explaining the new ABC Test and providing a list of sub-agencies within the California Department of Industrial Relations, including the Division of Labor Standards Enforcement (DLSE), the Division of Occupational Safety and Health (DOSH) and the Division of Workers’ Compensation (DWC).
Commencing in January 2020 the EDD will be conducting extensive training on the new legislation for auditors and other personnel. There will be no such thing as a kinder and gentler EDD. Audits will be more aggressive with little or no room to argue worker status issues. Along with tougher audits, will be additional penalty assessments.
I do believe that audits will be harder on employers and those engaging independent contractors whose occupations are not exempt under AB 5. The hazards of litigation before the CUIAB will be much greater and the future for deeply discounted settlements may be problematic. In my opinion, more audits should be settled instead of going before the CUIAB for a hearing on the merits, unless the contractors involved can demonstrate that they are truly in business for themselves.
If I could predict anything, at this point in time, I foresee more EDD audits as California sees a “cash cow” in worker status audits. More businesses will attempt to fly under the EDD’s radar , only to risk brutal assessments.
The Immediate Impact of AB 5 on the Business Community
While the impact of AB 5 is just beginning, some telltale signs are already apparent. In a recent editorial in a Los Angeles newspaper dated December 18, 2019 an anonymous writer discussed the impact of AB 5 on freelance writers. They have become a pariah. One company terminated close to 200 freelance writers and replaced them with 20 employees. Companies outside of California are not hiring California-based writers because they do not want to pay payroll taxes and other employer-employee expenditures. People are scared, confused, and are trying to find certainty in a sea of potential problems either way they turn. All signs point to things getting worse for us Californians.
Lawsuits are being filed in federal courts claiming that AB 5 interferes with the federal constitutional right to contract in matters involving interstate commerce.
AB 5 may be the most short-sighted piece of legislation ever enacted in memory.
Current Headaches for California Employers
Disclaimer: I am a tax attorney. I am not an employment attorney and I do not handle employment issues nor do I represent either employer or employee in labor relation issues. No decision on what to do in the future should be based solely on taxation considerations. You need to consult with an employment attorney before you make any final decisions or change your business model.
It seems clear at this point that some companies are going to have to reevaluate their business model. Under AB 5 a worker whom you treat as an independent contractor may, under the new law, be an employee. Let’s look at a hypothetical situation.
An individual whom you treat as an independent contractor gets into an auto accident while performing services for you. As an independent contractor he/she files a claim with a private health insurance carrier. The carrier denies coverage because, in their opinion, the worker is an employee. The worker is told to file a claim for Workers’ Compensation. This coverage is also denied because the worker was not listed as an employee when the policy was issued. This very unhappy worker is caught between the proverbial rock and hard place. Litigation against the employer is a real possibility.
Of course there is the typical problem when an independent contractor files for UI benefits, claiming he/she was an employee. This situation automatically triggers an EDD worker status audit. In the future, your best option may be keeping a low profile and not challenging the UI claim. What you say at the hearing will certainly be used against you in a subsequent audit.
Prospective employers need to get solid legal advice from an expert on employment law. There are many issues that you must now take into consideration. Here are a few:
- Labor Code § 2802 requiring employers to indemnify workers for out-of-pocket work-related expenses.
- Payment of minimum wage
- Overtime payments
- Workers’ Compensation Insurance
- Payroll Taxes, both IRS and EDD and the requirements for withholding and the filing of quarterly and annual payroll tax returns.
- Employers exposure to the Trust Fund Recovery Penalty (TFRP) per IRC § 6672.
- Employers exposure to the EDD’s version of the TFRP per CUIC § 1735.
- The Affordable Care Act for larger companies
- Health Insurance for smaller companies
- Paid sick leave and paid maternity leave
- Avoiding potential claims with the California Labor Commissioner
Once again, the above list is not exclusive. These are just a few considerations from a tax lawyer’s point of view.
Assuring Independent Contractor Status
AB 5 creates a rebuttable presumption that the worker is an employee. This means that arguments can still be effective for independent contractor status. There is, however, an unfortunate reality that an EDD auditor will still reclassify contractors as common law employees under new Labor Code § 2750.3. Here are a few suggestions that may help you when establishing yourself an independent contractor:
- Get a business license
- Take out liability insurance including malpractice insurance
- Consider forming a corporation or LLC, but at the very least, get a DBA.
- Obtain a federal EIN
- Take out a Workers’ Compensation Policy for your employees
- Have a well-drafted independent contractor agreement
- Pay your own out-of-pocket expenses, do not accept reimbursement from your customer
- Present an invoice that you prepare yourself, do not let your customer prepare the invoice.
- Have a web site or equivalent where you hold yourself out to the world to be in business for yourself.
We are all sailing on uncharted waters. There are no guarantees. Just because you pay big bucks to have a lawyer draft an airtight independent contractor agreement, does not mean that it will be recognized as such by an EDD auditor. Most EDD auditors brush aside these contracts in order to assess employment taxes, penalties and interest thereon.
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 40 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.
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