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What You need to Know about Converting Independent Contractors to Employees under California AB-5

On September 18, 2019, California Governor Gavin Newsom signed into law A.B. 5, solidifying a tighter standard of rules for classifying a worker as an independent contractor. The new standard, known as the Dynamex standard, codifies and expands the earlier California Supreme Court decision, Dynamex Operations West, Inc. v. Superior Court of Los Angeles. It replaces the former Borello test, and puts in place a more simple three-pronged ABC test. The significant effect is that many workers in California will now be classified as employees instead of independent contractors (also informally known as “1099” workers). This change is one of the most significant disruptions to California employment law in decades. The law took effect on January 1, 2020. FIND OUT how to comply with this law by downloading our easy-to-understand instructions.

Converting Independent Contractors to Employees

First, we recommend consulting with a qualified employment lawyer to determine whether your independent contractors will now qualify as employees, as there are some exceptions to this rule for workers in certain professions. Now that the law is in affect, as of January 1, 2020, you should determine whether you will need to reclassify some independent contractors to employee status. You can book a 30-minute consultation with one of our attorney’s.

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Step 1: Notify the Employee

Some employees may not be aware that the new California law reclassifies their job, especially if they have been working as an independent contractor for some time. Even if you have a signed Independent Contractor Agreement on file with a worker, if he or she should be classified as an employee, he or she must become an employee.

Notifying the employee in writing will allow you to keep a file on record of the date the status was converted, which can be helpful later in the event of an EDD audit or employee lawsuit or Labor Claim. To do this, use the Notice to Employee Form provided by the Department of Industrial Relations, and which is required by California Labor Code section 2810.5. This notice must be provided to the employee within 7 days of the change of status, pay, or benefits. We recommend providing this notice to the employee in advance of January 1.

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Step 2: Create an Employee File

Gather the necessary information needed from an employee including the following documents:

  1. I-9 form (must be completed in person and within 3 days of hire);

  2. W-4 form (check online on the IRS website for the latest version),

  3. Emergency contact information form,

  4. Job Offer letter;

  5. Detailed Job Description;

  6. Insurance and benefits enrollment forms (if applicable);

  7. Company property checklist;

  8. Signed Employee Handbook;

  9. DFEH-185 pamphlet on Sexual Harassment (also available in Spanish);

  10. Signed Safety Policies and procedures; and

  11. Any other information your company collects form new hires.

  12. Keep physical copies on record in a locked file cabinet, or online in a file or server to which only a select few owners and managers have access.

Step 3: Update your Payroll

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Once the worker is classified as an employee, he or she will need to receive wages through payroll. The wage statements must also reflect Paid Sick Leave (mandatory in California), Vacation or Paid Time Off (optional), and Cell Phone Reimbursement if the employee uses his or her cell phone within the scope of employment. This information and their new tax deduction information should be updated in your payroll management system. The employer will now begin collecting Federal Withheld Income tax, Social Security tax, and Medicare tax. In addition, you’ll be responsible for Federal Unemployment Taxes, as well as any state or local taxes in your area. In the event your company is audited by the California Employment Development Department and it determines that your employees were misclassified as independent contractors, you will owe back-tax on the portion of payroll taxes the company should have provided to the EDD.

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Step 4: Onboard your Employee

The employee should now be held to the same standards and receive the same benefits as other employees. New employees should receive and sign a copy of the company Employee Handbook (which should be updated annually) and any stand-alone policies; be subject to annual performance reviews; receive mandatory Paid Sick Leave; receive benefits, such as paid holidays, vacation/Paid Time Off; health/dental/insurance/retirement benefits if the other employees receive them; and payment for meal breaks and overtime if the employees are classified as non-exempt.

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Step 5: Distribute W-2 Forms

At the end of each year, these new employees will receive W2 forms in place of their 1099 forms. In the case that they were converted half-way through a tax year, they will receive both forms.

Considerations in Integrating Your New Employees

There are key considerations an employer must make for their new employees that did not apply when they were contractors:

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  1. Wage Rate: Employers must pay employees minimum wage for all compensable time. This rule applies to both hourly and salaried employees, including for training and travel time.

  2. Overtime: Non-exempt employees are eligible for overtime pay under the following conditions: (1) One and one-half times the employee’s regular rate of pay for all hours worked in excess of eight hours, up to and including 12 hours in any workday, and for the first eight hours worked on the seventh consecutive day of work in a workweek; and (2) Double the employee’s regular rate of pay for all hours worked in excess of 12 hours in any workday and for all hours worked in excess of eight on the seventh consecutive day of work in a workweek.

  3. Employee Handbook: The new employee will now be subject to all the policies laid out in the company handbook. They should review and sign the last page. The company must save a copy of the entire document, with the signature page, so that you have on file a version that the employee read. The Employee Handbook should be updated annually, and is required for companies with 5 or more employees.

  4. Meal and Rest Breaks: In California, an employee is entitled to a meal period of at least 30 minutes after working five hours (unless the total work period is no more than six hours), and is entitled to a second meal period of not less than 30 minutes if the employee works for more than 10 hours (unless the total hours are under 12). Employees are entitled to a net 10-minute rest break for every four hours worked. Meal breaks must be recorded on an employee’s time sheet for each day.

  5. Expenses: Develop an expense reimbursement policy and schedule. Reimburse employees on-time.

  6. Healthcare: Employers are required to provide health insurance coverage if it has at least 50 full-time employees or equivalents.

  7. Paid Time Off: Employees may expect other benefits, such as vacation pay, holiday pay, and personal days. While these employee benefits may not be required, their use helps with employee retention, and reduces the cost of having to find and train new employees.

  8. Paid Sick Leave: California has a mandatory Paid Sick Leave policy. Many cities and counties have their own requirements that exceed the state requirements. Consult with an employment lawyer on the rules in your city, and any cities in which your employees work at least 2 hours a week.

  9. Insurance: Employers may need to consider workers compensation insurance or general liability insurance depending on their industry.

Potential Consequences

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If employers fail to reclassify independent contractors as employees, they could face: tax fines for federal or state taxes that were required to be withheld but were not; fines for employee benefit obligations; Workers’ Compensation fines; unemployment compensation penalties and interest; unpaid overtime and minimum wage; waiting time penalties, and other penalties and interest levied by government agencies.

California has increased the number of Employment Development Department (EDD) audits intended to discover companies that have misclassified workers and impose steep fines on these businesses. If you have received an audit, contact a qualified employment lawyer immediately. You may be able to reduce the amount of money you owe based on certain facts in your case.

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