How the New Gig Economy Rules Affect Your IT Department
The ground shook for California businesses on January 1. Besides the global pandemic that has crippled the economy, the new year also signaled the start of AB5, new gig economy rules that significantly impact the hiring of California-based independent contractors.
Almost every business in the Golden State must pay attention to AB5, especially firms that use contractors for IT services.
That’s because AB5 clarifies and formalizes a 2018 California Supreme Court ruling that introduced an ABC test for determining if a worker is an independent contractor or really an employee by a different name. Many current contractor situations are banned now, and businesses that continue hiring independent contractors must watch their step or find themselves with penalties and having to reclassify their contractors as employees.
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Not as Easy as ABC
AB5 clarifies the 2018 ruling, and provides some necessary exemptions. But the basics remain the same, including the ABC test for determining if a worker is a contractor or an employee.
The three prongs of the ABC test:
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 the work and in fact.
B) The worker performs work that is outside the usual course of the hiring entity’s business.
C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
If you’re paying attention, you probably gulped hard when reading this list. IT relies heavily on contractors, and the ABC test poses a significant challenge to this model. The new gig economy rules don’t give IT workers an exception, either.
“Fortunately, IT workers are more likely to pass the new stricter ABC Test enacted under AB5 than many other categories of contract workers,” says Holly Sutton, a partner at law firm, Farella Braun + Martel. “This is because the second prong of the test, which poses problems for many employers, is easier to satisfy for IT workers.”
That second prong requires that contractors perform work that is “outside the usual course of the hiring entity’s business,” which means many contractors hired to assist employers in completing core business tasks are now disqualified under AB5.
But most businesses relying on IT contractors are not in the business of IT. They just need IT staff for operational support.
“Those non-IT employers are likely to satisfy the most difficult hurdle of AB5 with respect to their IT contractors,” she notes. “Of course, employers must also satisfy the other two prongs of the test, and ensure that their arrangement with their IT contractors are modified, if necessary, to meet those other requirements as well.”
Learn More: IT Hiring After California’s AB5 Legislation
So let’s look at what it takes to meet those requirements.
Your Lifeline: The B2B Exemption
“A lot of IT departments have routinely engaged individual consultants or ‘freelancers’ to address unusual questions or temporary peak workloads,” says Jeff Brown, a partner at law firm, Payne & Fears. “Under AB5, those freelancers are likely to be considered employees.”
The workaround, he says, is AB5’s B2B exemption. The exemption allows a business to hire another business to perform services if some key criteria are met.
Contractors Must Have a Legal Business
Freelancers and sole-proprietors are out. All contractors hired for your IT needs must work through a legal entity such as a corporation or partnership, a business that has other paying clients, routinely performs similar work, and controls its own processes and hours. This is a B2B exemption, not a business-to-person exemption. So California businesses can no longer hire that “IT guy” who works under his own social security number.
Contractors Can’t Work Directly with Customers
Because it is a B2B exemption, IT contractor firms can only work with your business, not directly with your customers. Working directly with your customers implies the contractor might possibly be performing a core business function and actually be an employee.
“The outside provider must provide services to the IT department and its employing company itself rather than to the company’s customers,” stresses Brown.
Contractors Need the B2B Exemption Spelled Out in their Contract
Written contracts with all contractors are a must, and they should specifically mention that the contractor is serving under the B2B exemption. Yes, all your contracts will need an update.
“Informal arrangements should be updated to include a formal written agreement which reflects the nature of the business relationship,” says Sutton.
Contractors Need Their Own Place of Business
Virtual businesses with no physical office or a home office that doesn’t pass IRS muster are out. All contractors need their own dedicated place of business that isn’t their bedroom or a space made available by the client. Contractors who work from home or a coffeeshop look suspiciously like freelancers as opposed to true businesses.
“This last requirement could be problematic for companies who have typically relied on individuals working out of their homes,” notes Brown. “Under AB5, even a person possessing his or her own tools and equipment, and capable of providing services with little or no direction, may still fall under the definition of an employee.”
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“A” is for Autonomy
Even with the B2B exemption, which covers the B and C of the contractor test, California businesses still face the issue of ensuring that their IT contractors are not acting like covert employees—the “A” in the ABC test.
The independence of independent contractors has always been built into the definition, but many businesses have nibbled away at the line or skirted it entirely because historically nobody cared all that much outside of the legal profession. With AB5, the independence of contractors matters and is rigidly enforced.
“Managers as well as contractors should be trained to ensure that they understand the distinction between contractors and employees, and are abiding by those new, stricter practices,” says Sutton.
These include:
Projects instead of Hourly Rates. Contractors work by the project or the milestone, not by the hour. There are some exceptions, but hourly billing is a red flag that the contractor might not have independence.
Schedule Freedom. Typically, contractors set their own work hours and operate independently. There are exceptions, but contractors that sit in on staff meetings or have prescribe hours look like employees.
Own Tools. Businesses don’t provide the tools that contractors need for performing the work, and they don’t typically reimburse. Instead, the contractor bills more to independently purchase the needed tools or cover things like travel expense.
Minimal Process Oversight. Contractors decide how they perform the work within the specifications of the contract. Businesses don’t manage the “how” for their contractors, they only specify the outcomes to be achieved.
Project Selection Independence. Contractors choose the work they perform, they aren’t employees required to carry out orders from upper management. This means that work is mutually agreed upon instead of unilaterally decided by your business. If a contractor can’t say no, they are an employee instead.
AB5 is significant legislation that definitely impacts the IT department of businesses in California. If you haven’t already adjusted for AB5, now’s the time.
This article is for informational purposes only, and does not constitute legal advice.
