In 2020, a change in California law introduced a higher standard employers must meet in order to properly classify workers as independent contractors. Though that law (“AB 5,” codified in Labor Code sections 2776-2787) is now over five years old, it can still be challenging for employers to navigate, and violations can have costly consequences for nonprofits.
Though California enacted AB 5 largely in response to rideshare services and a growing “gig economy,” the law impacts other businesses as well, including nonprofits. For example, many nonprofits work with consultants, grant writers, or graphic designers. Depending on the nature of the organization’s programming, nonprofits may also hire tutors, musicians, or referees. Employers might assume that workers in these categories (and others) can be classified as independent contractors. But under AB 5, does your nonprofit actually need to hire these individuals as employees?
Answering this question requires a careful, thorough legal analysis, that should be conducted on a case-by-case basis. As a starting point, below are five key considerations for nonprofit employers to ensure compliance with AB 5.
Prior to AB 5, California courts used the Borello test to evaluate whether employers had properly classified members of their workforce as independent contractors. The Borello test evaluated multiple factors to determine whether an individual was an independent contractor, and not all of the factors had to be met in order to establish independent contractor status.
AB 5 codified a new, more stringent test for independent contractors, known as the “ABC test,” which was first adopted by the California Supreme Court in its 2018 Dyanmex Operations West v. Superior Court (2018) 4 Cal.5th 903. There, the Court held that workers are presumed to be employees, unless an employer can prove that all of the following are true:
(A) The worker must be free from the control and direction of the hiring entity, both under the contract and in fact;
(B) The worker must be performing work for the hiring entity that is outside the usual course of the hiring entity’s business; and
(C) The worker must be customarily engaged in an independently established trade, occupation, or business of the same nature as the work they are performing for the hiring entity.
What does “free from the direction of the hiring entity” mean for purposes of prong A of the ABC test? What qualifies as work “outside the usual course” of your nonprofit’s business to satisfy prong B? And what does it mean for a worker to be customarily engaged in an independently established trade or business under prong C?
When determining whether a worker meets the A prong of the ABC test, a nonprofit should consider whether it allows the worker to decide how to get their job done. In other words, if a manager or director closely supervises and directs the worker in the performance of the tasks they were hired to complete, that weighs against the idea that the person is properly classified as an independent contractor. Independent contractors must retain autonomy, which should be reflected in their written contract with the nonprofit and in practice.
To satisfy prong B, which is in many ways the hardest of the three, a worker must legitimately perform functions that are not part of the nonprofit’s core operations. In other words, consider how integral the worker’s tasks are to your organization’s fundamental, regular services. If the individual’s work falls outside of those typical services, in the sense that they are truly working in a separate business, different from yours, that would be a positive fact for establishing prong B.
Prong C is the most objectively measurable aspect of the ABC test. Does the individual run their own business? Does the individual have business cards, a website, their own written contract, and a business license? Does the individual set their own rates? Do you generally get the sense that you are hiring a company, not just an individual person?
In sum, the stronger the evidence of autonomy in the workplace and independent business activity, the more defensible the independent contractor classification.
Labor Code sections 2776-2783 carve out several exemptions for occupations and certain arrangements that remain subject to the Borello test instead of the ABC test for determining independent contractor status. For example, certain licensed professionals such as attorneys, architects, engineers, private investigators, accountants, and licensed landscape architects may still be evaluated using the Borello factors. Similarly, certain professional services providers such as marketing, human resources administrators, travel agents, graphic designers, grant writers, fine artists, freelance writers, photographers and photojournalists may be subject to the Borello test instead of the ABC test. Additionally, a “Business-to-Business” exemption to the ABC test allows contracting relationships between a “business service provider” providing contracted services to a “contracting business” to be governed under the Borello standards instead of the ABC test.
Note, however, that these exemptions do not automatically apply. To meet an exemption, the nonprofit organization seeking to rely on them must be able to prove that certain statutory requirements were met, such as showing that the contractor has a business location separate from that of the hiring entity, retains the ability to set their own hours, and sets or negotiates their own rates for the services performed.
If an employer inadvertently misclassifies a worker as an independent contractor, the worker may bring a lawsuit against the organization and argue that the organization should have hired them as an employee instead of as an independent contractor. A plaintiff in this position may seek various forms of damages against the organization. The most common claims are wage and hour claims, where a worker claims unpaid wages, including overtime wages and premium pay for missed meal and rest breaks. These lawsuits are difficult to defend, are not typically covered by insurance, and can be extremely costly for an employer.
The Labor Commissioner can also bring claims for noncompliance and willful misclassification against employers. Other enforcement actions for misclassification may include actions for unpaid contributions to the unemployment insurance fund brought by the Employment Development Department, and penalties imposed by the Internal Revenue Service for payroll tax violations.
In summary, navigating how to properly classify workers has always been difficult and AB 5 made it harder, even with the various exceptions enacted over the last few years. Accordingly, nonprofits working with independent contractors should regularly audit their contractor positions to identify potential misclassification issues. LCW attorneys are available to advise and assist with those sorts of audits and suggest approaches to mitigating risk, such as strategies for reclassifying workers as employees.