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Worker classification is a heated issue. Whether the government would classify a worker as considered an employee or a contractor has a huge impact on the employer. Federal and state law requires employers to pay taxes for an employee but have much less responsibility for contractors. The government is fierce in its prosecution of those who it claims wrongly classify an employee as an independent contractor to get out of these obligations — and it just got a new tool that makes it even more difficult for business owners to hire independent contractors.

What is this new tool?

In January of 2020, a new worker classification law, AB5 went into effect. The law was promptly challenged within the state’s court system.

What is AB5?

AB5 essentially created a new worker classification test. In order for an employer to treat a worker as an independent contractor, businesses must show the workers meet all three of the following elements:

  • Worker is free from the control and direction of the employer or hiring entity, both under written contract and through actual performance of the job;
  • The worker completes tasks outside the usual course of the employer or hiring entity’s business; and
  • The worker is already part of an independently established trade or business as is completed when working for the hiring entity.

The law impacts a number of different businesses. One of the most notable during the coronavirus pandemic is the use of Instacart, but Lyft, Uber and trucking companies are also fighting back against the law.

The law exempts certain professions, such as licensed insurance agents, physicians, lawyers, commercial fisherman and a broad category defined as “other professional services” that includes fine artists.

How does this impact tax obligations?

Employers will need to review their worker classification to ensure it follows AB5. If not, they will need to make changes to reflect this new law. A failure to do so, or an attempt to classify a worker one way for state tax obligations and another for federal taxes, will likely result in a tax audit.