Bookkeeping Tip for California Businesses: Navigating Independent Contractor Classification (AB5)

The Tip: Be meticulous about classifying your workers correctly as either employees or independent contractors, and ensure your bookkeeping reflects this accurately. California has strict laws, notably AB5, that can result in significant penalties for misclassification.

Why it's important for California businesses:

• AB5 ("ABC Test"): California uses a very stringent "ABC test" to determine if a worker is an independent contractor. Essentially, a worker is presumed to be an employee unless the hiring entity can prove all three of the following:

  • (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 that involved in the work performed.

    
    

• Penalties: Misclassifying an employee as an independent contractor can lead to severe penalties, including:

  • Unpaid wages (minimum wage, overtime)

  • Unpaid payroll taxes (Social Security, Medicare, state unemployment, disability insurance)

  • Workers' compensation premiums

  • Penalties from state agencies like the EDD (Employment Development Department) and the Labor Commissioner.

  • Lawsuits from workers.

• Bookkeeping Impact:

  • Payroll vs. 1099: Employees require payroll processing, withholding various taxes, and issuing W-2 forms. Independent contractors receive gross payments, and you'll issue a 1099-NEC (Nonemployee Compensation) if payments exceed a certain threshold.

  • Expense Tracking: The types of expenses you can deduct and how you track them differ based on worker classification.

  • Record Keeping: You need to maintain specific records for employees (timecards, wage statements, personnel files) and different records for independent contractors (contracts, invoices, proof of their independent business).

Actionable Advice for Bookkeepers:

• Review Worker Agreements: Regularly review contracts and the actual working relationship with any independent contractors to ensure they meet the ABC test criteria.

• Educate Your Clients: Many small business owners in California are unaware of the nuances of AB5. Educate them on the risks and requirements.

• Maintain Separate Records: Keep clear and distinct records for employees and independent contractors.

• Consult Legal Counsel: If there's any doubt about classification, advise your clients to consult with an attorney specializing in California employment law.

• Stay Updated: AB5 has seen amendments and continues to evolve with court interpretations. Keep abreast of the latest developments.

By being proactive about independent contractor classification, California businesses can avoid costly legal and tax issues, and bookkeepers play a crucial role in guiding them through this complex landscape.