On June 30, 2022, the U.S. Supreme Court decided not to review AB5. As a result, the injunction on AB5 that has been in place for over two years will be lifted, and AB5 will be law in California, retroactive to January 1, 2020. Assembly Bill 5 (AB5) is a California law that restricts businesses from classifying workers as independent contractors rather than employees. The bill was driven by unions wanting to organize workers. Experts believe it will increase labor costs, create higher costs for consumers, reduce the quality of service, and most importantly, reduce the flexibility of workers. The bill is largely opposed by companies like Uber, Lyft, and Door Dash because it was initially created to try to combat these business models. Unfortunately, the bill will unintentionally affect all independent contractor truck drivers in the state of California by making it difficult to work for themselves.
AB5 is based on an April 30, 2018, California Supreme Court ruling on a case known as Dynamex. The Dynamex ruling establishes a presumption that workers are employees unless the hiring company can prove otherwise. Prior to the Dynamex case, the Borello test (in place since 1989) was an 11-prong test that most independent workers (owner operators) were able to pass. The Dynamex ruling replaces Borello with a new 3-prong test, called the ABC test, to determine if a person can be qualified as an independent contractor.
The three prongs of the ABC test that must be passed are as follows. A) The worker must be free from the control and direction of the hirer in connection with the performance of the work. B) The worker must perform work that is outside the usual course of the hiring entity’s business. This is the prong that creates the most trouble and is almost impossible to pass for owner operators leased to trucking companies. C) The worker must be customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.
Some independent contractors are exempt from some of the implications of AB5 including doctors, dentists, insurance agents, lawyers, accountants, securities brokers, real estate agents, hairstylists, and many creative professionals. However, even if you are exempt from AB5, you must still pass the Borello test to be qualified as an independent contractor. Owner operator truckers are currently not exempt from AB5.
One potential solution to AB5 is for carriers to utilize a “two-check system” to pay their drivers. Although rare, these two-check systems have been around for many years. Under the two-check system, the driver is no longer an independent contractor but is instead an employee of the carrier. At the same time, the driver has a rental agreement to rent his equipment to the carrier. The first check is for the driver as an employee, and the second check is for the rental of the driver’s equipment. However, there are nuances that can make this difficult.
These two-check systems can be difficult, because now the carrier is renting the truck, so they can technically put any driver they want in it, especially if the primary driver is taking extended time off. Another example is that some believe they can pay the employee driver minimum wage and then put the rest of the money towards the rental of the truck. But it’s likely in this scenario that the IRS will consider this as shielding income. A third issue is that as an employee, the driver can no longer choose when to work, how much they want to work, what loads they want to haul, or any of the other myriad of reasons that drivers choose to be independent contractors instead of employees.
The two-check system does, however, come with some serious issues and risk. The IRS generally considers that all payments to an employee are subject to payroll tax unless a specific exemption applies. IRC 62 does allow a deduction for reimbursement of an employee’s business expenses, including the use of an employee’s vehicle. But such expenses are only deductible by the employer where the employer maintains an “accountable plan” setting forth a qualifying expense allowance arrangement with the employee. As part of the plan, the employee must specifically itemize and substantiate all vehicle and other expenses to be paid by separate check. If the IRS requirements are not met on audit, all employer deductions will be reclassified as income payments. The employer will be assessed payroll taxes on 100% of the reimbursements, going back for years, along with interest and penalties.
In the meantime, the trucking industry will continue to work towards solutions, because there is a significant concern that AB5 will quickly spread to other states like New Jersey, Illinois, Washington, and New York, just to name a few. The current administration would like AB5 and the PRO Act to be the rule of the land and would prefer all people to be employees and members of a labor union.
As things stand today regarding AB5, the most common options we see carriers offering their owner operators with California residences are: 1) Move residence out of California. 2) Get your own operating authority and drive for the trucking company’s brokerage division (this option creates a significant amount of costs and increased administrative and compliance responsibilities). 3) Become an employee. 4) Deadhead out of California, because you can legally deliver loads into the state, but you cannot legally pick up loads in California. 5) End your relationship with your carrier.
With the Supreme Court refusing to review AB5, it is now law in California, retroactive to January 1, 2020. Thus, if you are an owner operator with a California residence, AB5 forces you to make immediate and significant changes to how you operate your business. Here at NTA, we are already seeing some of our clients moving to other states like Nevada and Arizona. This is because most owner operators are independent contractors by choice and have no desire to become employees. Whatever steps you plan on taking, we hope it works out for the best. If you have any questions, feel free to give us a call at (800) 805-0040 or send me an email at wayne@ntassoc.com, and we will assist you as best we can.
