Actual Costs: Converting Independent Contractors to Employee Status
As you learn more about AB5, you face the potential reclassification of your workers. How much will it cost to convert these workers from independent contractors to employees? Direct Reclassification Costs are the most apparent expenses you will pay, such as payroll, benefits, and taxes. You can quantify direct costs by comparing them to the cost of current employees. Alternatively, many small and medium-sized businesses have opted to enlist the services of a Professional Employer Organization (PEO) to make reclassification less burdensome. TEXT US us if you'd like to get set up with a reputable PEO serving your industry or call 1-760-413-9274. CALL US
Your PEO should be able to provide close estimates regarding the direct costs associated with classifying each person as an employee, including taxes, impact on workers’ compensation insurance, health insurance, unemployment insurance, and more factors.
Indirect Reclassification Costs
Indirect reclassification costs are harder to identify and quantify, but a PEO can help. Examples of indirect reclassification costs include the money you will be paying for increased HR support to oversee and manage recruitment, hiring, retention, and training. In addition, as your employee base grows, your need for HR services increases as well.
Bolstering Contractor Status for “Gray Area” Workers
Many of your workers may reside in the “gray area” – people who could fall under either classification. You might choose to keep them classified as employees or decide that it’s better to manage contractor classifications. Once you establish employees vs. contractors, you need to be ready to build your case.
If you leave these workers as independent contractors, you need to be proactive about establishing the evidence to prove their contractor status based on the requirements outlined in AB5. The written contract is an essential detail. Even if you are only hiring one independent contractor, this document needs to look like a business employing another business.
Depending on your business model, the cost-benefit analysis might not justify the reclassification of independent contractors. It can be helpful to work with a PEO or legal counsel to consider other options based on the viability and nature of your business. When independent contractors fall in the “gray area,” you may consider whether contractors can be based outside California. This option is particularly valid for administrative support services such as payroll specialists and consultants.
Finally, as you evaluate risk, you may choose to continue operations as usual regardless of potential legal 6 challenges down the road. In some situations, business owners make the decision to continue operating without re-classifying contractors as employees. The decision is usually based on the premise that it is not feasible for the business to remain profitable should it have to incur the costs associated with re-classification. If this decision is reached, businesses should:
- Retain legal counsel to develop a defense strategy should they face litigation
- Begin planning for business model adjustments to rely less on independent contractors in California
Logistical Considerations for Reclassification
A wide range of logistical adjustments are necessary to reclassify workers. Again, you must comply with AB5 requirements when using independent contractors.
For example, if you run a delivery business and use independent contractors on an as-needed basis during your busy season, you’ll likely have to re-classify the workforce to part-time employees. In this instance, will the employees have set schedules or fixed routes? Will they be able to set their own hours? These job-specific responsibilities will have to be thoroughly considered, as the wrong decision could result in morale or productivity decreases.
The overall costs and logistical details vary from industry to industry and business to business. However, logistical considerations boil down to adjusting workflows to maintain profitability and productivity. For example, some companies realize cost savings by not paying for higher-rate workers. Others set off in search of technological efficiencies that can offset a leaner workforce.
As you evaluate your options, ask yourself: Can part or all of the cost savings be passed along to the customers? Will a portion of increased costs cut into your bottom line?
Reclassification is Viable - How Do You Implement?
Once worker classification analysis is complete and you see that reclassification is viable, it’s time to design an implementation plan. Follow these four steps for a smooth transition:
1. Strong Internal Communications Strategy
Shape your messaging to send the proper communication to contractors. Help workers see the benefits they will receive by becoming an employee. Independent contractors often resist reclassification as an employee, so you need to show them the available benefits. These benefits include eliminating self-employment tax issues, workers’ compensation insurance access, and the camaraderie of working with others as a team. Talk to your legal counsel and be ready to answer complex questions, such as employees asking why they weren’t an employee all along.
2. Consider Optimal Timing
Next, you need to determine the right timing for reclassification. You can make the switch any time, but it might reduce paperwork and other issues by reclassifying at specific points during the business year. For example, making the change at the end of the year means you can start fresh in the new year – eliminating the hassle of co-mingled tax years for contractors and employees. 7
3. Add Extra Perks to Incentivize New Employees
Independent contractors often enjoy the flexibility that comes with being “their own boss,” which is why many workers don’t want to become employees. But extra perks can soften the blow of these changes. Consider offering a flexible schedule or part-time options. Consider what the workers will miss most about being an independent contractor and look for ways to integrate these details into the employee structure. What is their pain point, and how can you solve these problems? For example, maybe payroll taxes hinder cash flow, and you can overcome these issues with pay increases or bonuses.
4. Enlist Committed HR Support
It takes more work to manage a team of employees than independent contractors. Hiring a PEO is a great way to access HR consulting services. In addition, a professional team makes the transition smoother by giving you access to ongoing Human Resources support and employee management solutions.
Addressing Potential AB5 Retroactivity Issues
AB5 went into effect on January 1, 2020, which has some employers wondering if retroactivity is a concern. Reclassified “employees” might start asking whether the business will provide benefits for previous months or years when they were classified as a contractor. Retroactivity is still being litigated, but its potential effects on business finances could be extreme.
What do you do about these retroactivity issues? Most employers don’t choose to offer back pay or compensation. There’s no sure answer that works for every business, which is why you need to be ready to talk to your lawyer about the situation if someone makes these claims.
If a significant number of workers are concerned about retroactivity, then businesses could be facing a risk when one or more workers engage legal services, resulting in a class-action suit. You can reduce this risk with legal preparation before reclassification. However, the best thing you can do to protect against legal action is to ensure all re-classified employees are taken care of. Keeping your workforce satisfied will be your best defense against this type of action.
Using a PEO to Ensure AB5 Compliance
Running a business takes a lot of time and energy, and it’s no surprise that many business owners are overwhelmed by AB5 compliance requirements. As you are considering worker reclassification, it’s critical to ensure that you are carefully navigating labor laws while still maintaining profitability.
A PEO can help companies navigate AB5 to minimize the potential effects of these labor laws. Employers must carefully navigate the transition of moving independent contractors to employee status. At the same time, a strong case and solid documentation are essential for employers choosing to maintain independent contractor status for certain workers.
The truth is that most businesses aren’t equipped to handle this process in-house. It involves a change in payroll, shifts in worker management, and a new set of challenges due to taxes, compliance, and more. In addition to the immediate costs of reclassification, you also need systems to review contractors to avoid mistakes in the future.
A Professional Employer Organization (PEO) provides a proven structure for handling the transition and supporting employee needs. Working with a PEO means that you have instant access to a payroll system and workers’ compensation insurance.
Hiring a PEO simplifies the reclassification process because you can plug new employees into the system without redesigning the system from scratch. Even though it can be expensive to transition your business model from independent contractors to employee status, this process could potentially force you to close your doors.
Don’t get caught off-guard with compliance issues. Instead, invest in the future of your business with professional services to consult on classifications, minimize employment risk, develop efficiencies, and create a happier, more productive workforce overall.
TEXT me if you'd like to get set up with a reputable PEO serving your industry - 1-760-413-9274
If you are like me when I first started dealing with labor misclassification and wage theft back in 2013, you feel conflicted about what to do with all of these laws, which are even more overwhelming than they were back then.
The passage of AB5 will arguably, shape the future of labor in California and the Nation. Even with the amendments passed by the legislature, and with the Uber Proposition 22 which passed further carving out exemptions for selected classes of businesses, the next decade may be a tumultuous and uncertain time for business owners, and even some workers.
I know how it feels to be sure of your cause and case and then how it feels to be kicked in the gut by a reality that it's not IF I was going to pay in a wage theft and misclassification lawsuit, but rather, HOW MUCH? Guilt or exoneration mattered in the letter of the law, but not in the spirit of it's intent, which was to provide workers with competitive pay and benefits while not giving "cheaters" a competitive business advantage over those that comply with the law and "pay their fair share". Even if you're paying your workers more as independent contractor, all of that becomes irrelevant when the authorities come knocking so to speak.
The conflicting truth is: Not all workers want to be employees and some businesses provide better pay than their counterparts paying an hourly rate, as well as, not all workers are exploited nor are all owners using independent contractors, nefarious criminals.
There are many instances where a worker benefits more by the flexible nature of the independent contractor relationship and also earns more based upon a desired output productivity and not based upon the time spent on the clock.
But once a judicial ruling like Dynamex becomes codified into the statutes of the state constitution, the analogy looks a little like this: the light you see at the end of the tunnel ... isn't the end, it's an oncoming freight train and you will either be in front of it or on it.
I can share with you my experiences being on the receiving end of the law, but I cannot offer you legal advice. Only an attorney can offer legal advice and my insight in no way is meant to be provided or received as such. I've spent plenty of money over the years for good legal advice for my businesses in order to navigate the litigious minefield of California business and labor operations.
Additionally, I've been through an IRS audit and several liability insurance audits for my general liability policies, in addition to a wage theft and misclassification suit mentioned earlier, and had found ways to comply with the law prior to AB5, both working with employees and independent contractors.
Over the years, another local business owner and friend has passed regular inspections of his books by the EDD to operate with an independent contractor and employees. That's all a thing of the past ...now all of his workers are employees (and as an owner, he's earning less due to the financial encumbrances added by the AB5 legislation).
Most business cannot pass part B of the ABC Test and must, therefore, convert to employees, find a legal exemption or cease operations if they do not want to run afoul of the California State authorities. You don't want to be in violation of this law.
Begin the ABC Test in the form below