There are many common employment issues that start-ups might face. Weintraub attorneys Meagan Bainbridge and Ryan Abernethy help review these issues in a two-part series for California Employment News. Join them in part one, which covers independent contractor classification and employment exemptions.
Watch this episode on the Weintraub YouTube channel here.
Welcome to the latest episode of California Employment News, a video podcast series from Weintraub Tobin’s Labor and Employment Group. I’m Ryan Abernethy, an employment attorney here at Weintraub Tobin, and joining me today is my colleague and shareholder here at Weintraub, Meagan Bainbridge. So this is the first episode of a two-part series that we’ve put together for startup companies, where we’ll be delving into some of the most common employment issues that California startups face. So in this episode, we’ll be going over independent contractor classifications and employment exemption issues, which are kind of the first steps that a startup faces. And then in the next episode, we’ll cover the obligations that apply to employees in California and some best practices for startups to comply with those laws in order to avoid lawsuits. So, Meagan, can you tell us a bit about how to distinguish between independent contractors and employees?
Yes, of course. Thanks, Ryan. Before hiring anyone, the first thing a startup must do is determine whether they are hiring employees or independent contractors. The key difference between an employee and an independent contractor for purposes of today’s discussion, is how that worker is paid. In the case of an employee, the employer issues form W2 and is required to withhold federal and California employment taxes on the wages independent contractors are paid subject to various other laws. In the many years that Ryan and I have been doing this, I think we’ve both seen a tendency from startups to label its initial workers as independent contractors as they work to start up the business. While certainly we understand this logic, it’s important for all new employers to understand that, well, at least in California, the assumption is that all individuals who do work for an employer should be classified as employees. In recent years, the state has taken a strong stand against the independent contractor classification, and in doing so has passed new laws making it increasingly difficult to classify any person as an independent contractor. In fact, it doesn’t matter if both the company and the employee desire to classify an individual as an independent contractor.
The only thing that matters is whether the ABC test can be met. This means that under the current law, any worker who meets the following criteria is presumed under California law to be an employee. First, that the worker is free from control and direction of the company and performing their work. This means that a business doesn’t control the precise manner or details of the work being completed, and that the individual is largely dictated or largely dictates how the work is performed. Number two, the worker performs a function that is not within the company’s typical business. Typically, we find this is the most difficult element to establish, in that proving that the worker is not performing a function inside the company’s typical business. A common example of where services are not considered to be part of the hiring entity’s usual course of business would be an example, such as where a retail store hires an outside plumber to fix a leak in the bathroom. That work that the plumber is performing is outside the scope of that retail store. On the other hand, if a clothing manufacturer hires a seamstress to work from home making designs to then sell in the retail store, then that likely would be work performed within the scope of that company’s typical business.
In number three, the worker frequently engages in that same function independently or as a trade or business with others. In other words, here, the individual operates as their own business and performs similar work for others. The difficult part here is that you often will have no control as to whether or not that individual actually does perform work to others. And if they don’t, that can render the individual an employee through no fault of yours, of course, because nothing’s easy. The legislature has laid out a few exemptions to this presumption. Ryan, can you tell us a little bit more about those exemptions?
Yeah, so the ABC test freaked out a lot of companies, understandably, and startups weren’t exempt from that. But fortunately, the California legislature has, over time, kind of siloed off certain types of relationships and certain categories of industries and whatnot that are considered exempt from the ABC test, and I’ll go through some of those. The first one is what’s called the professional services exemption. And this exemption covers outsourced work from marketing professionals, for example, HR administrators, digital content aggregators, payment processing agents, and several other types of workers of that nature. Those who are all exempt from the ABC test, provided they also meet a separate six factor test, which I’m not going to go over today. There’s also referral agency exemption, and that tracks with the business model of many tech and app-based startups that Meagan and I have seen. This referral agency exemption applies to specific areas, including but not limited to graphic designers, photography, web design, even dog walking, and several other referral-based services, provided they meet a separate eleven-factor test in that instance, which, again, we won’t be going over today. In addition, the business to business exemption is one that many startup models can utilize, provided they meet certain criteria.
Unlike the other exemptions we’ve talked about, this exemption is not limited on the workers performing specific types of services. It applies to individuals who conduct business as sole proprietors or partners in a partnership, members of a limited liability companies, and to corporations generally. The legislature has also identified several specific industries that are now generally exempt from the ABC test. For instance, freelance writers and editors. They can qualify if they meet several additional requirements app-based ride shares and delivery services, certain real estate agents, construction subcontractors, and contracts for various single engagement events. But something to understand for each one of these exemptions is that in almost all instances, even when one of the exemptions apply to the ABC test, the startup must still show that the old Borello test still applies. And what the Borello test is, it’s basically part A of what Meagan went over. It’s the degree of control. So they want to make sure that under the old standard, that the company isn’t exerting too much control over that worker, such that it looks more like an employment relationship. When in doubt. I mentioned all these factors and considerations and various tests before they apply.
So when in doubt again, it’s best to speak with an attorney on these issues. So now that we know how to determine who are workers and who are employees, Meagan, how can startups determine which employees are exempt and which are non-exempt?
Yeah, so once you’ve determined you have an employee and not an independent contractor, the next step is to determine whether the employee is exempt or nonexempt. The key difference between exempt and nonexempt employees is that nonexempt workers are entitled to certain protections under the laws that set minimum wage, overtime requirements, mail and arrest breaks, things like that. Both under California and federal law. It’s important to understand that the presumption is that all employees are non-exempt unless you can establish that they meet a certain exemption. The most common exemptions include the executive exemption, administrative exemption, exemptions for outside and inside salespersons and computer professionals. Each of these exemptions, of course, has its own set of strict factors that must be met. It’s not enough simply to say, hey, that person’s an exempt employee. You actually have to prove that they are. My partner, Lucas Clary and I just finished an expansive four-episode series totally focused on these pay exemptions, and I encourage you to check those out if you think you might have employees to qualify otherwise. That does it for today. As you’ve seen, California startups operate in a dynamic and ever-evolving employment legal landscape.
And by staying informed about worker classifications, you can proactively address potential legal challenges and ensure a solid foundation for your startup success. Please join us for the second part of this series while we will discuss the nuts and bolts of employing people in compliance with the California Labor Code and other relevant employment laws. You can continue to find the California Employment News on our blog at theLElawblog.com and wherever you listen to your favorite podcast. We’ll see you next time.