Tag Archive for: Assembly Bill 5

A 2021 EDD Audit will include classification criteria from the Borello Test and the ABC Test

Watch our video below to learn how the last 12 quarters affect your EDD audit criteria.

Have You Received an EDD Audit Letter?

The California Employment Development Department (EDD) sends audit letters through the mail. If you receive an audit letter, you have 30 days to reply. Typically, the agency audits back three years from the most recent tax filing. However, EDD sometimes will audit the previous year’s tax filings.

Right now, for example, an EDD audit period would span from 2018 to 2021; the standard 12 quarters (three years time). At this time, that means that your audit process will include the years before AB-5 was signed into law and those years after. EDD audits in 2021 will look different because of the two different verification methods: AB-5 and the Borello test.

What is AB-5?

The law in California named AB-5, effective January 1st 2020, changed the way EDD classifies workers as either W-2 or 1099s. Before January 1st, 2020,  the old rule, the Borello test, was in effect. The Borello test was broader and in the grey zone on who could be classified as a 1099 contractor.

In the case of current California EDD audits, auditors are making determinations on both the old rule for the appropriate time period and on the new ABCs of contractor classification as set forth in AB-5.

Because of this, in some cases, there may be a worker who is classified as an independent contractor under the old rule, and as an employee under the new rule because they don’t meet the more stringent requirements.

According to the California Department of Industrial Relations, workers are employees, not independent contractors unless all of the following requirements are met:

  • “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 the work and in fact;
  • The worker performs work that is outside the usual course of the hiring entity’s business
  • The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.”

Under AB-5’s rules, 1099 contractors have to meet all three of the ABC’s of contractor classification to be considered to be a 1099 contractor. If they fail to meet even one classification, they’re automatically classified by EDD as a w-2 employee.

In audits that misclassification is proven, EDD can assess you for payroll taxes and penalties, and interest calculated based upon total payments made.

What is an Unemployment Audit?

Unemployment audits, otherwise known as Unemployment Insurance (UI) benefit audits, are also performed by EDD. The federal-state unemployment insurance system provides temporary wage replacement for those who have lost their jobs. The EDD conducts benefit audits periodically to protect the integrity of the UI program.

These audits aid in lowering employee UI costs. New employees are assigned a 3.4% UI rate for two to three years of employment, which fluctuate after that set time depending on your contribution to UI benefits. EDD can take from 1.5% to 6.2%, but the taxable wage limit caps at $7,000 per calendar year.

EDD benefit audits are conducted on a daily, monthly, and quarterly basis to ensure that UI is distributed to eligible claimants only. They are done by matching the information provided by employers against information provided by individuals who have filed a UI claim.

There are four types of unemployment benefit audits:

  • New employee registry benefit audit
  • National directory of new hires
  • Quarterly wage earnings
  • Interstate crossmatch

If you receive a benefit audit, respond with the completed audit form within 10 days of receiving the notice. For more information on the different types of EDD benefit audits, read our “What is an EDD Benefit Audit?” article.

What Should You Ask Yourself Before an Audit?

Before your company experiences an EDD audit, take the time to go through a profile for your 1099 contractors to ensure they have a legitimate business.

Questions to Ask:

  • Do they have clients?
  • Do they advertise?
  • Do they have their own website?
  • Do they have a business license, tax certificate, or EIN?

For some California cities, if you do business in that city, you’re required to get a business license specific to that location. For instance, if you’re a subcontractor performing work in multiple cities because you have a job that happens to be, for instance, in Del Mar (which is in San Diego and in Riverside), your subcontractors may need to get licenses just to complete that job.

To check the status of your contractor’s license, visit the California Contractors State License Board (CSLB) website. There, you can input your independent contractor’s eight-digit license (located on the contractor’s plastic pocket license), and the website will check if they are licensed under CSLB. The agency will then check the contractor’s:

  • License number
  • Business name
  • Personnel name
  • Home Improvement Salesperson (HIS) number
  • HIS name

Contractors’ licenses can expire or be revoked in the middle of a job so we recommend diligently checking that each contractor has a current license. This will help avoid the fines and penalties of an EDD audit. Click here to learn CSLB’s 10 tips for hiring a licensed contractor.

How Do I Verify My Worker’s Status?

If you are unsure of the correct worker classification there are services that will run independent contractor reports to verify the status of your 1099 hires as legitimate 1099 contractors.  Then you as a business owner can make an informed decision before an audit begins.

If your report uncovers that your workers are misclassified, you can then take the next steps to correctly classify them, or work together with your workers to ensure they then meet the criteria to become a 1099 contractor.

EDD audits are time-consuming and a hassle. Business owners undergoing an EDD audit should be prepared for each step of the process. Read our article on what to expect in an EDD audit for more information.

 

workers must meet all three criteria of the ABC test to be classified as an Independent Contractor

Dynamex, AB-5 and Prop 22 explained

Who is Dynamex and what did they do?

Watch our video below:

 

Dynamex was a nationwide same-day delivery and courier service. They employed their California drivers as W-2 employees who received the benefits, payroll taxes, and perks of being a W-2 employee. However, in 2004, the company reclassified all of its California drivers into 1099 independent contractors to save employee costs. 

 

With reclassified 1099 independent contractors, Dynamex then avoided paying their portion of employee payroll taxes, medical benefit costs, or other employee benefits costs. It saved them money at the expense of their workforce.   

 

After their reclassification, an employee filed a lawsuit against Dynamex for misclassifying him as an independent contractor and stripping him of his employee benefits. This lawsuit turned into a supreme court ruling that ultimately led to a completely new and stricter reclassification system than what was set in place before. 

 

The California Division of Labor stated that the Dynamex case misclassifications alone cost the state $7 billion each year. 

How did AB-5 come to be? 

The Supreme Court ruling on the Dynamex Operations West, Inc. v. Superior Court on April 30, 2018 changed the regulations for employers to classify workers. Before the ruling, worker classification was based on the unclear 13 Factor Borello Test. As a result of the ruling, the court created the California Assembly Bill 5 (AB-5) that included the new and clearer ABC test for employers to correctly classify workers.

 

AB-5 was signed into law by California Governor, Gavin Newsom, in September of 2019 and went into effect January 1, 2020. This is not just another bill. The new AB-5 law directly affects the way Small Business Owners (SBOs) who hire Independent Contractors will operate in California. The law impacts ALL SBOs. 

 

This new law redefines the way you as a business owner must classify your workers. It will now push California business owners to employ workers as W-2 employees and pay for benefits and protections (unemployment, overtime, sick leave, and worker’s comp) that employees get under California Law. 

 

There are several exceptions for specific industries and job categories. For those industries, the worker classification guidelines under Borello remain the standard by which EDD will determine worker classification. 

 

As of January 2020, California Employment Development Department (EDD) places the burden of proof on business to show that workers are correctly classified as 1099 contractors and that they should not be reclassified as employees under the stricter criteria set out in the new law. 

 

The new AB-5 law raises standards for many California workers to determine worker classification.

What is the ABC Test? 

The ABC test is AB-5’s new guideline for how to properly classify workers. In order to classify a worker as a 1099 independent contractor instead of as a W-2 employee,  they must meet all three criteria

 

  1. 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 the work and in fact;
  2. The worker performs work that is outside the usual course of the hiring entity’s business; and
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

 

What is the Borello Test? 

The 13 Factor Borello Test was the first method to classify workers. While the ABC test is now the new regulation and standard for worker classification, the Borello Test is still used today. Employers hiring exempt employees can fall back on this test to classify workers. The test asks the following 13 questions. 

 

  1. Do you instruct or supervise the person while he or she is working? 
  2. Can the worker quit or be discharged (fired) at any time?
  3. Is the work being performed part of your regular business?
  4. Does the worker have a separately established business?
  5. Is the worker free to make business decisions that affect his or her ability to profit from the work?
  6. Does the individual have a substantial investment in their job which would subject him or her to the financial risk of loss?
  7. Do you have employees who do the same type of work?
  8. Do you furnish the tools, equipment, or supplies used to perform the work?
  9. Is the work considered unskilled or semi-skilled labor?
  10. Do you provide training for the worker?
  11. Is the worker paid a fixed salary, an hourly wage, or based on a piece-rate basis?
  12. Did the worker previously perform the same or similar services for you as an employee?
  13. Does the worker believe that he or she is an employee?

 

Who Benefits from AB-5?

Beneficiaries of the stricter classifications are:

 

  • Workers in the gig economy who want to be able to unionize
  • Those working full time without benefits and who will, under AB-5 have to be offered benefits, protections, and earnings guarantees.

 

An example of a beneficiary of the new law might be 1099 workers for a large cleaning company who work fewer than 40 hours but only for one company, and do not have the benefits or protections of being an employee. These workers would, under the new law, be classified as employees and would be offered benefits, unemployment insurance and protection under the labor laws from being fired without just cause among many other W-2 wage-earning employee benefits. 

Who is at a disadvantage with AB-5? 

Companies who will find that AB-5 puts them at the biggest disadvantage in this new classification system are small to mid-sized business owners who want a flexible workforce by employing workers to help when times are good and then scale back either seasonally or due to market conditions. 

 

These small business owners will have to pass a much stricter analysis in order to be able to hire 1099 workers as opposed to W-2 employees. The burden of proof lies with the employer to prove that a worker is correctly classified as a 1099 contractor. and EDD will request proof that 1099 contractors have a legitimate business starting in January 2020.

 

Another group that may find the new law puts them at a disadvantage is the independent contractor who prefers to remain a 1099 contractor. According to Forbes and Gallup, 36% of US workers are in the Gig Economy. 

 

Retired people choose to pick up work, just like many recent grads and stay-at-home parents. For most of these workers, they don’t mind a 1099 contractor status and they do not want to be managed as a W-2 wage earner. For those workers, these new AB-5 classification rules are not offering any tangible benefits, they are creating impediments. 

 

Surveys done by Intuit in 2016, found more than 90% of contract workers prefer the flexibility and personal control they have as independent contractors. They can accept or reject a job based on the amount offered, timing, or indeed any reason – these workers work only when they want. 

What does this mean for Uber, Lyft, and other Rideshare programs? 

Uber, Lyft, and HopSkipDrive drivers may have to choose one “employer” and thereby not be able to pick up as much work in a given period of time. The ramifications of this shift will certainly affect both companies and workers. 

 

In order to find a solution to converting rideshare workers into employees, and keep them as independent contractors, Prop 22 was created. This piece of legislation sought to sidestep AB-5 regulations so that rideshare workers can remain independent contractors instead of becoming W-2 employees. 

 

Thus, they remain eligible to work when and how they want, and for as many rideshare app companies as they wish. Learn more about what Prop 22 means for you in our article here. 

Dynamex turned their W-2 employees into 1099 independent contractors. This stripped wither workers of their benefits and caused the Supreme Court to create AB-5