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AB 5 & Workers' Compensation Explained

ab 5 & workers’ compensation explained

We partnered with John Milikowsky, the founder and managing attorney of Milikowsky Tax Law to discuss Assembly Bill 5 and how it correlates with Workers’ Compensation. John is a seasoned tax lawyer who understands the ins and outs of government agency audits. Through his experience working with hundreds of EDD, CSLB, and IRS audit cases, John and his team of experts understand how to protect business owners in the face of an audit. Get to know the Milikowsky Tax Law office here.  

what does assembly bill 5 mean for companies?

Assembly Bill 5 (AB-5) is a federal law that passed in January 2020 that introduced further regulations for independent contractor classification.  Previously, there was only the 13-Factor Borello Test. Under AB-5, the ABC test is used to set the standard for worker classification. All workers are considered W-2 employees unless they meet all three of the following criteria according to the California Labor Workforce Development Agency:  

  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 that is involved in the work performed.” 

Let’s unpack the three criteria. First, when it comes to your 1099 independent contractors, employers cannot hold control over workers. Examples of areas businesses can control workers, intentionally or unintentionally include: 

  • Uniforms 
  • Your company’s business card with your independent contractor’s name on it
  • Requiring the independent contractor work specific hours 
  • Accepting money from a customer and then paying your contractor 

Generally, if you employ an independent contractor, they function as an independent business. The worker has the freedom to work when they choose, and how they choose within the parameters of their contractual agreement. Independent contractors should receive money directly from the third party that is receiving their services. 

The second element is that your company’s services and the services of independent contractors should be different. If an independent contractor is providing your core services, the second element cannot be met. 

For example, let’s say you own a plumbing company that hires both W-2 and independent contractor plumbers. They both provide the same services and do not meet the second criteria of the ABC test. However, a residential plumbing company hired for a commercial job may decide to hire a specialized commercial plumber. Since the residential plumbing company typically does not do commercial work, they might qualify under the second element of the ABC test to distinguish between what the contractor does and what your company does. 

The third element is that the contractor has to have an independent trade or business. The EDD generally requires a business license, and potentially an EIN number. Having a corporation or an LLC is a great added bonus. The independent contractor should have entrepreneurial risk in their company to show that they have an independent business. 

what does that mean for workers’ compensation? 

Workers’ compensation carriers are indifferent to the distinction between an independent contractor and a W-2 employee. As far as they’re concerned, if you’re on a job and your work product is under the control of the insured, then that employee is a covered employee. 

This process typically comes to light during the annual audit at the end of the workers’ compensation policy. The insurance company will ask, “do you hire independent contractors?” If the answer is yes, and that independent contractor cannot prove that they have their own workers’ comp coverage, then the carrier will pay heavy fines and penalties for that exposure because ultimately, there’s coverage there.

what happens when a workers’ compensation carrier finds an independent contractor? 

In the construction industry, when a workers’ compensation carrier identifies an independent contractor, the Contractor and State Licensing Board (CSLB), EDD, Labor Commissioner, and OSHA, will descend upon a job site and start asking questions of everyone on site. If the government agency finds people who are independent contractors without a license, that potentially becomes a criminal issue, and also a rise for an EDD audit. 

if a carrier finds a misclassification on the stateside for payroll, how does that affect the audit on the workers’ comp side?

At that point, the workers’ compensation policy auditor will determine the value of compensation paid to that supposed independent contractor. They then will charge the employer the premium for the wages related to that relationship. This occurs whether or not the employer or policyholder knew that their policy was not limited to covering only W-2 employees. If any insured or uninsured independent contractors wanted to, they could make claims on the employing companies’ workers’ compensation policy.

This creates liability for the hiring company. Business owners who have any doubts about whether a worker is an independent contractor or not should be sure to do their research and make sure that they meet the three elements of the ABC test. As previously advised, limit your liability because anybody can file a claim against your business. The workers’ compensation carrier then would have to make that determination. Learn more about what you need to know about changes in tax codes here