What Does AB5 Mean From a Tax Perspective in California?

So in January of 2020, California Legislature passed AB5 which governed the relationship between companies and their workers. Basically what AB5 states is that unless a hiring entity can prove that a worker is truly independent according to three specific factors, that worker will be deemed to be an employee of the company itself. The factors are number one, the company must not have in any condition of control over the work. Number two the worker services must be outside the core business or the hiring entity and number three the worker must maintain their own separate and independent business. So this was all raised with much fanfare and rightly so was called the death of independent contractors in California because unless you qualify for one of the exemptions that's under the statute, pretty much all workers fall within an AB5 framework and they can be deemed employees. It's only those that are providing true outside services like they have bookkeeper or CPA or law firm or videographer that really qualify outside the scope of AB5. The statute really is meant to pull as many people as possible into the employee relationship however from a tax perspective despite all the fanfare on the labor side, it doesn't really have any impact. The reality of the situation is that the EDD has been using an AB5 framework for quite some time. So what I mean by that, well the reality is that when you go through an employment tax audit, EDD is already looking at control. Control was a previous factor under the old past and now really

what the EDD is focused on is is the worker integral to the revenue generation function of the particular business? So if the worker helps you earn revenue and they're somewhat essential to your business then they're your employee and so reality is before AB5 California auditors and administrative law judges were already thinking into this framework and so even though there's a lot of noise about what's going to happen now that AB5 is and I had to switch all my workers over to w2 and get audited the reality is you were probably going to get audited anyway. California, through their enforcement actions, has been focused on this issue for quite some time and it's really important that you understand what the framework is going in. The reality of the situation is with most independent contractor audits for 2020 and beyond the story is about damage control. How do we minimize the damage or misclassification issues because the reality is is you probably will not beat this test unless you can show your workers are truly independent businesses and they fall outside the revenue generation framework. So I want you to think outside the lines when it comes to tax on this issue and you need to get as proactive as possible. If you're not in compliance already I strongly encourage you to do so to avoid the potential penalties and other consequences associated with not complying with law.


Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law