Assembly Bill 5 (AB5) and Independent Contractor Agreements in California

California's new gig economy law was meant to help workers. But it will likely hurt them instead

California’s AB5 became law January 2020 and it will help define the future of the rideshare transportation industry in California and beyond… the future of earning income as a rideshare driver.

Independent contractor agreements in California may be affected by this new law, but the final outcome is far from decided at this point.

It’s interesting I think, most new articles present the idea that AB5 automatically makes California rideshare drivers employees… AND since that didn’t happen most articles argue that Uber, Lyft, Grubhub, etc. are ignoring the law… some articles even suggest now that AB5 is law these Gig Economy companies are in violation of the new law.

 

AB5 Targets Independent Contractor Agreements in California

California’s new law, Assembly Bill 5 (AB5), took effect January 1st, 2020, but California’s Lyft and Uber rideshare drivers are still independent contractors.

My regular readers aren’t surprised… they understood AB5 becoming law was not going to force Uber and Lyft to make California rideshare drivers employees.

When writing the language for AB5 California lawmakers did the “right” thing; meaning instead of targeting the rideshare industry directly… they focused on what they believed was at the root of the “rideshare problem”… namely rideshare drivers should not be classified as independent contractors… they should be classified as traditional employees.

At some point California lawmakers realized there are a lot of independent contractors in California who could be affected by AB5… and rideshare drivers represent only a small portion of a much bigger group. 

No worries, the politicians writing the bill just exempted a number of professions from AB5.  The exempted professions could continue as independent contractors.  (For more on this point see my blog post Lyft and Uber Driver Rights – What Are They?)

 

 

Why are there so many people working as independent contractors in California?

Decades ago, I worked independent contractor “jobs.”  For over 10 years I did not have a “traditional” job and the income I received was documented using IRS 1099 form.

When I filed my taxes, I used IRS form Schedule C – Profit or Loss for a Business.  The profit from my business activities were documented/calculated on the Schedule C form with the net profit (after expenses) transferred over to the standard IRS 1040 as a source income.

During those contracting years I didn’t have many IRS-allowed tax deductions (business-related expenses) so most of what I earned as a contract worker transferred over to the standard 1040 form as taxable gross income which was subject to the standard income tax everyone pays.

Rideshare drivers transfer only a portion of their income from their Schedule C because they can deduct their business miles which for 2019 is $0.58 cents per mile… this means a healthy portion of what I earn completing passenger trips for Lyft and Uber is not transferred to my 1040 as taxable income. 

My Schedule C – Profit or Loss for a Business forms for my rideshare driving activity definitely are not reporting a financial loss…. but after the generous IRS mileage deduction a large portion of my rideshare driving income is not subject to the income tax.

If this sounds to you like rideshare drivers are paying too little in income tax… remember we are paying 100% of the expense to own and operate our vehicles… the tax deduction just means we aren’t paying income tax on funds required to maintain our vehicle and recover what we paid for the vehicle.

 

AB5 Defines a Test for Classifying Workers

But hold on… this blog post is not about filing taxes as a rideshare driver (a topic covered in my book Driving for Uber and Lyft - How Much Can Drivers Earn?) this blog is about the presumably unintended effects of California’s AB5 law and how California’s new law will shape the future of being a rideshare driver.

Some Californians would like to see AB5 force Uber, Lyft, and other Gig Economy companies to reclassify their independent contractor workers and make them employees… but AB5 does not force any action by businesses using 1099 independent contractors… AB5 defines a test to determine the correct way to classify California workers.

Decades ago, when most of my income came from 1099 independent contractor work, there was a federal government test an employer could use to determine if a worker should be classified as a W2 employee or a 1099 independent contractor. 

The same federal government independent contractor vs. employee test still exists today… this test is the reason millions of workers in California and the rest of the country are considered independent contractors.

The IRS test is not a law… if it were law the U.S. Constitution prohibits state law from overwriting federal law which would arguably make AB5 unconstitutional.

 

 

AB5 Forces Employers to... Do Nothing

Funny thing is… while AB5 is law… it’s just a test too… AB5 does not force employers to do anything. 

AB5 documents a test California employers are required to use to determine how to classify workers (1099 vs. W2)… the difference from the IRS test is AB5 has the force of law in California… this means there is now a clearer path for lawsuits claiming worker(s) are mis-classified.

To better understand the present… let’s look at the past… which might give us an idea what the future could look like for all U.S. rideshare drivers?

It might help our understanding of why California lawmakers drafted the AB5 test and passed it into California labor law if we have a good understanding of the IRS test.

Here’s a short summary from the IRS website:

 

“The general rule is that an individual is an independent contractor if the payer [employer] has the right to control or direct only the result of the work, not what will be done and how it will be done.”

 

Remember for rideshare drivers outside of California the IRS test is still the legal standing for a case that rideshare drivers are incorrectly classified as independent contractors. 

Drivers outside of California can still bring mis-classification lawsuits but they would have to argue that the long-standing IRS test should not apply to rideshare drivers.

 

Rideshare Drivers are Independent Contractors

Using the IRS test, I believe rideshare drivers are correctly classified as independent contractors … my thinking is driven by the key phrase in the IRS summary of what makes an independent contractor:

 

“…payer [employer] has the right to control or direct only the result of the work…”

 

Clearly “the result” of the rideshare driving work is safely transporting a passenger from Point A to Point B.  That’s it… anything else a driver does is really just their personal style.

As an independent contractor a rideshare driver is paid for completing each individual passenger trip… each trip is a separate “job” known in the Gig Economy as a “gig.”

Important for our thinking… a rideshare driver can choose when to work; for how long; and can choose to not accept a “gig” request from the software application or cancel an accepted trip request for any reason except the legal definition of discrimination. 

A driver controls if they want to go online, complete a single trip, then be done for the day/week/month.

Pretty cool way to earn income… few independent contractors can turn down work for weeks or months and then when they choose start earning again as if they never took the time away from the contracted work.  From this point of view rideshare driving is independent contracting on steroids.

 

Lyft and Uber Community Guidelines

Anyway… “control” is the key point for the IRS test and some people argue a significant measure of control is imposed on drivers via Lyft and Uber’s “Community Guidelines” documents. 

The Community Guidelines define mostly behavioral expectations for passengers and drivers (how we interact with each other during a passenger trip)… the Community Guidelines do not tell drivers “what will be done and how it will be done” when they transport a passenger from Point A to Point B.

As example, I could make all passengers sit in the back seat of my car unless there were enough people to warrant a front seat passenger.  (Something I did about six months into my first year as a Lyft and Uber driver… I call these my three “dark months” as a rideshare driver.)

 

 

IRS Test: Behavioral Control

After the summary the IRS website provides two major categories in their test (Behavioral Control & Financial Control) for determining the correct way to treat a worker… employee or contractor.

The first major category from the IRS test:

 

“Behavioral Control:  A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised. Behavioral control categories are:” (summarized in the bullets below)

  • “…when and where to work…”

 

Clearly rideshare drivers choose when and where they work.

Some drivers posting on online driver forums would have us believe rideshare drivers don’t really have that choice… these drivers say “in order to earn the most income you have to work busy times and busy parts of the city…” 

In other words, these drivers say when and where they work is controlled by the TNCs (transportation network service like Lyft and Uber) simply because certain times/places are the best times/places to earn the most income in the least amount of time.

I’m calling nonsense on that argument… the TNCs don’t control the best times/places to earn… passengers choose when and where they request a rideshare trip… drivers control the choice to complete passenger trips in the “right” places and at the “right” times.

If a driver wants to sit waiting for passenger trip requests during a statistically slow time of day… on the outskirts of a big city (or anywhere in a city with a small population) they are free from TNC control and can make that choice.

 

  • “…what tools to use…”

 

As far “tools to use” it is a common misconception that Lyft and Uber define what type of vehicle a driver must use (year/make/model) but those rules are defined by individual state and city governments. 

It’s true to qualify for the luxury level passenger trip requests Lyft and Uber define the type of vehicle a driver must use… but in this case Uber/Lyft are simply defining the type of vehicle they are selling when a passenger pays for the higher priced service. 

Drivers control the choice to drive a luxury vehicle hoping to earn more income when completing the luxury level passenger trips.

 

 

For basic level rideshare transportation the city/state defines what vehicles are acceptable essentially mirroring rules designed for taxi vehicles.  The city/state regulations define minimums, drivers control the choice to complete trips in vehicles that exceed the minimum requirements.

The next sub-point in the IRS Behavioral Control category: (again summarized)

 

  • “Degree of instruction…”

 

What the IRS says here is more detailed instructions may mean a worker is an employee and less instructions means less control, so a worker is more likely an independent contractor.

Again, outside the Community Guidelines (which are guidelines and not rules that have to be followed) Lyft/Uber do not define the exact way a driver delivers the “results.”

Some would argue the Community Guidelines are rules (not just guidelines) because a driver (or passenger) can lose access to the service provided by Lyft and Uber for violating Community Guideline “rules.”

If a driver or passenger violates a behavioral expectation defined in the Community Guidelines they could be suspended or permanently banned from accessing the TNC software application… because this is true, I agree (more or less) with the argument that the Community Guidelines are essentially rules.

To understand my “more or less” take on this point let’s look at the use of profanity while passengers are in the driver’s vehicle… something covered in the Community Guidelines.

If I had a general contractor construction company and used independent contractor carpenters… and I stopped using a carpenter because they were constantly using profanity while on the job site that doesn’t mean my goal is to control the worker which could arguably make the contractor an employee.

I asked the contract carpenter to stop using profanity because I was concerned about my business reputation… the contractor didn’t stop using profanity so I stopped using that contractor… their services to complete carpentry “gigs” were no longer requested or required by my company.

I didn’t hire the carpenter, I offered them work, they accepted the work… I defined a community guideline that it was not acceptable to use profanity while completing carpentry work for my general contracting company… when the independent contractor carpenter made clear they weren’t willing or able to meet that guideline I stopped using their services.

The same would be true if an independent contractor was doing other things that a company believed was potentially causing them to lose business to a competitor… even for reasons not covered in the Community Guidelines.

In the case of rideshare transportation this might mean a driver who always turned down short trips… passengers might request rides from the competition because they were turned down by a representative of the first company they tried.

I think there is a strong argument a company should have the right to protect their business success by enforcing reasonable constraints on the behavior of contracted workers and I believe the Community Guidelines define reasonable behavioral constraints.

So yes, the fact that a driver could be banned from completing future passenger trips for a given TNC does make Lyft/Uber Community Guidelines seem more like rules than guidelines… in my opinion this reality alone does not mean rideshare drivers should be reclassified as employees.

I see it this way… business owners must have reasonable control over the “community” where services are delivered.

 

 

Next IRS Behavioral Control sub-point:

 

  • Evaluation systems to measure the details of how the work is done…

 

The evaluation system for rideshare drivers is the star rating system and might qualify as an argument that rideshare drivers are subject to “an evaluation system to measure the details…” and maybe should be classified as employees; however, we must remember the IRS web page we’re exploring is not a black or white definition of employee vs. independent contractor… the IRS provides a test for employers… employers make the worker classification choice.

This is a very important point because AB5 works almost exactly this way… it’s not a black and white definition… it is a test for employers to use when they make the choice how to classify a worker. 

With the advent of AB5 as law a California worker can cite AB5 in a lawsuit arguing they have been misclassified as an independent contractor… using a law as basis for a lawsuit makes a stronger legal case.

My current take on the star rating system is it works well enough to help the TNCs identify potential “problem” drivers and passengers.

The star rating system is essentially a survey… if a lot of passengers are giving a driver consistently lower ratings (compared to the average for all drivers) there could be a problem that could be negatively affecting the TNC’s business success.

Enough on the star rating system for now… as I said the current system works well enough to help the TNCs identify potential “problem” drivers and passengers.

Final sub-point from the IRS Behavioral Control category:

 

  • “Training… how to do the job…”

 

This one is simple… employees are trained… independent contractors are not trained… contractors are expected to show up for work with the skills required to do the contracted work.

“The work” is picking passengers up where they are… and delivering them to where they want to be… this means “the skills” required to achieve “the results” are possessed by almost every adult in America… the ability to drive a car or truck.

Outside of instructions on how to use the driver application the TNCs do not train drivers... they can’t… providing training is a strong indicator that a worker is an employee. 

In some cities there are trainings for drivers who were deactivated due to lots of negative passenger feedback… but those trainings are delivered by third-party companies not by the TNCs.  After passing the course the driver can petition the TNC to be reinstated.

 

 

IRS Test: Financial Control

The IRS guidelines to employers includes a second major category:

 

“Financial Control: Does the business have a right to direct or control the financial and business aspects of the worker's job?”

 

The IRS guidelines for this category are explored in the sub-points bulleted below:

 

  • “Significant investment in the equipment the worker uses in working for someone else”

 

Independent contractors make a significant investment in the tools required to complete the contracted work… for example an independent contractor carpenter owns their own tools and brings them to the job site.  The company does not provide basic carpentry tools.

It doesn’t matter if a rideshare driver uses a vehicle they own, rent, lease, or are paying off over time… the TNCs do not provide the vehicle meaning the driver is clearly making a “significant investment in equipment.”

 

  • “Unreimbursed expenses, independent contractors are more likely to incur unreimbursed expenses than employees”

 

Since the TNCs do not reimburse rideshare drivers for any expenses (most rideshare driving expenses are vehicle-related) this sub-point clearly suggests independent contractor and not employee classification.

 

  • “Opportunity for profit or loss is often an indicator of an independent contractor”

 

A rideshare driver can operate at a loss. 

 

 

For example, a driver in a city with a small population could invest in an expensive vehicle and because of a lack of business from the small population never earn enough from rideshare driving to make the monthly payments on the vehicle.  The driver eventually sells the vehicle at a loss.

Rideshare drivers using a vehicle they would own even if they weren’t a rideshare driver are unlikely to experience a financial loss from rideshare driving activities even in a city with a small population.

A driver using a vehicle they would own for personal use has already made the vehicle investment so the income from completing passenger trips only has to cover the additional expense created by transporting these passengers.

Rideshare driving income and expenses are variable… a driver in a brand-new expensive vehicle is incurring more expense compared to one driving a used and less expensive vehicle.

There is an opportunity for a driver to have more profit… more “take home pay”… dependent on their current and long-term expenses… and most importantly for the question of independent contractor vs. employee each driver controls the independent choices that determine the amount of expenses they incur as a rideshare driver.

While it’s unlikely most rideshare drivers would incur a real financial loss… some former drivers who got out on the road in a brand-new, expensive vehicle with unfavorable financing might disagree with me… I touched on vehicle choice in my blog Rideshare Vehicle Choice is Critical. 

It’s also easy to find current and former drivers writing online saying they wore out a vehicle rideshare driving and were left with a car or truck that was worth next to nothing. 

These drivers warn potential new drivers not to try rideshare driving stating that there are no real profits from rideshare driving… they argue that drivers are simply cashing out the resale value of the vehicles and not really earning any profits.

Not sure what they thought they were doing when they made the choice to try rideshare driving… obviously putting miles on a vehicle is going to reduce future resale value and along the way there will be maintenance/repair expenses? 

The fact that a driver “wore out” a vehicle doesn’t mean their rideshare driving venture was a financial loss… I paid $8,000 for my used 2006 Toyota and driving full-time hours have earned over $40,000 gross income every year I’ve been a driver… way more income than I’ve spent on my vehicle.  (For detailed, step-by-step directions to calculate all expenses for any vehicle check out my book Driving for Uber and Lyft - How Much Can Drivers Earn?)

 

The next sub-point in the IRS “Financial Control” category:

 

  • “Services available to the market. Independent contractors are generally free to seek out business opportunities.”

 

Drivers are free to complete passenger trips for any TNC including competing companies like Uber and Lyft. 

I complete trips for Uber and Lyft… when I’m waiting for my next passenger trip request, I almost always have both applications turned on, when I accept a trip on one platform, I turn the other one off. 

Drivers can choose to complete passenger trips for cash payment.  They are contractually forbidden to “steal” passengers they meet via the Lyft/Uber application but if they want to have their own passenger transportation business and find their own passengers Lyft/Uber cannot/does not prevent them from doing so.

Drivers are also free to do any other kind of work because they have 100% control over when they choose to go online with Lyft, Uber, or another TNC… 100% flexibility over when they choose to work.

 

  • “Method of payment. An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time even when supplemented by a commission. However, independent contractors are most often paid for the job by a flat fee.”

 

Another easy one… rideshare drivers are paid for completing passenger trips, they are not guaranteed a “regular wage.”  (See my blog post Base Pay or Living Wage)

Driver’s total earnings are a bit more complicated than “a flat fee”… but simply put drivers are paid to complete passenger trips… something like “piece work” contracting. 

Drivers can also earn incentives… for example for completing a specified number of passenger trips in a given period of time… but again there are zero income guarantees and if a driver doesn’t complete any passenger trips, they will not earn any income.

So there it is… an exploration of the IRS test used for decades for determining if a worker should be classified as an independent contractor or employee… and in my opinion, following the current IRS guidelines there is no question rideshare drivers are independent contractors and not employees because drivers are not controlled by the TNCs.

AB5 Doesn’t Even Mention Rideshare Drivers

So now we get to the article referenced for this blog titled: California's new gig economy law was meant to help workers. But it will likely hurt them instead.

I suspect like me when you read the title you assumed the article was saying rideshare drivers would be hurt by AB5… that remains to be seen.

As I stated at the beginning of this blog most of the recent new articles present the idea that AB5 becoming law in January 2020 automatically makes independent contractor rideshare drivers employees… AND that Uber, Lyft, Grubhub, etc. are ignoring the law and are possibly in violation of the new law.

The article referenced for this blog soft sells the “law breaker” idea but implies the same thing and it is simply not true:

 

“The unstated assumption of lawmakers here is that companies will simply comply with the law and convert those gig jobs into full-time positions.”

 

There it is… “comply with the law!”

You and I know that the AB5 law is really just a test… yes it’s a law but it’s the kind of law where there is “wiggle room” and if an independent contractor worker believes they are misclassified they can choose to sue citing AB5 as the reason they believe they should be treated as an employee.

Why an individual worker would want to bring a lawsuit rather than just walking away and finding some other way to earn income is beyond me… but that’s a conversation for another day.

  • There are strong rideshare driving lobbying organizations in California who believe rideshare drivers should be employees
  • There are likely California city attorney offices looking at the question of rideshare driver: contractor vs. employee
  • There will be lawsuits in the future… and that’s where the rubber will start meeting the road

Uber's lead lawyer Tony West has been very clear about what AB5 does not do:

 

"Contrary to some of the rhetoric we’ve heard, AB5 does not automatically reclassify any rideshare drivers from independent contractors to employees. AB5 does not provide drivers with benefits, nor does it give drivers the right to organize. In fact, the bill currently says nothing about rideshare drivers." 

 

Uber’s Tony West goes on to explain what AB5 does do:

 

“What AB5 does do is fairly straightforward: it inserts into the California labor code a new legal test that must be used when determining whether a worker is classified as an independent contractor or an employee.”

 

AB5 Is Affecting California Gig Workers

There it is… AB5 is a test… a roadmap of sorts to help companies determine if a worker should be classified as an employee or can be treated as an independent contractor and paid via IRS form 1099.

So now we understand that AB5 provides a path for a worker in California (or workers; or a city attorney) to sue a company claiming incorrect classification.

The article referenced for this blog begins to tell a story that is far from over… a story about the real-world effect of California’s AB5.

The first article I saw about the job-killing effect of AB5 told the story of a software developer who chooses to work as an independent contractor.  Late in 2019 businesses that had used his services for years communicated that they were no longer going to use California-based independent contractors.

I’m guessing the companies that are choosing to no longer use that software developer have legal departments telling them to limit the businesses risk and stop using California-based contractors.

The referenced article, along with a lot of other sources, reports another negative consequence of AB5… independent contractor journalists dumped… they got their pink slips weeks before Christmas 2019:

 

“Earlier in December, Vox Media, citing AB5, announced it was parting ways with about 200 independent contractors who contributed to its sports news site SB Nation. Vox may have been one of the first to cut ties with its California gig workers, but it will not be the only one.”

 

Ouch man!  Merry Christmas?!!!

AB5 even has a carve out for 1099 independent contractor writers… commonly called “freelance” writers… according to AB5 a single news outlet can publish up to 35 articles per year from a given freelance writer before they have to classify that writer as an employee.

Even with the carve out I guess Vox Media decided it was just easier to not use California-based freelancers?

This action makes sense… Vox Media has a legal department; I’m guessing legal said: “Better safe than sued at some point in the future… just use freelancers based in other states.”

So, we’re back to legal… back to lawsuits… which again is what it will take for AB5 to have a direct effect on Lyft and Uber rideshare drivers.

I don’t agree with the referenced article’s dire take on a potential consequence:

 

“Rather than bring companies that rely on gig workers to heel, the law could cause Uber, Lyft and others to simply turn off their apps, just like Vox let go of its contractors.”

 

Uber, Lyft, and others pulling out of California completely? 

Not likely, but who knows? 

One thing is certain… AB5 sets the stage for lawsuits… a large California city attorney might take the lead and sue Uber, Lyft, Grubhub, etc. using AB5’s “ABC Test” to argue application-based rideshare and delivery drivers in their city should be classified as employees… the city might even win the case.

If that happened… just to make a point I could see the big Gig Economy companies leaving a single California city, even San Francisco or Los Angles (#2 & #3 highest revenue cities for Uber) it wouldn’t be the first time Uber and Lyft “voted with their feet” and showed what can happen when they are backed into a corner.

 

 

Uber and Lyft Could Easily Leave California

One reason I believe they would be willing to pull out is because they know it would very likely be only a temporary loss of income… this tactic worked in Austin, Texas - in 2017 Austin attempted to force Lyft and Uber to use fingerprinting background checks for all drivers… a year later the State of Texas swooped in overriding Austin’s fingerprinting demands and brought Uber and Lyft back to the streets of Austin.

In my opinion rideshare transportation in general and Uber and Lyft specifically have passed the point where government bullying will be an effective tactic to force them to reclassify workers as employees… passengers want transportation and if they lose rideshare transportation as an option in their city there will be you-know-what to pay.

The rideshare companies are ready to compromise with California… they said as much before AB5 became law… but passing AB5 makes clear California’s politicians aren’t looking for middle ground… at least not yet.

Other certainties… government entities outside of California are paying attention… hopefully the negative outcomes of AB5 will help them make better choices about what if anything to do in their states?

In my next blog post we’ll explore the changes Uber has already made effecting California drivers… changes indirectly related to AB5 becoming law.

I’m still doing research on the next blog post but on first pass most of the changes look like they will be good for California drivers and Uber says they will evaluate rolling out the changes to other cities in the future… so stay tuned to my weekly blog posts on Rideshare Business Guide.

The passing of AB5 (and the very interesting aftermath) proves rideshare driving is a constantly changing “gig” in the Gig Economy.

This is why I was careful when writing my book How to Be a Lyft and Uber Driver – The Unofficial Driver’s Manual to provide simple and flexible guidelines that will help new and existing drivers maximize their income and minimize their stress now and well into the future in a constantly changing environment.

If you are still “on the fence” whether rideshare driving would be right for you click here to download a free copy of my Rideshare Earnings Case Study.

My Rideshare Earnings Case Study documents over two years of my detailed earnings results… the great days and the just-okay days.  Along with over two years of my daily detailed earning results the Rideshare Earnings Case Study also provides summaries of my average earnings and shows how using simple, easy-to-follow methods documented in my books my income went up from average $18 per hour to over $24 an hour.

The aftermath of AB5 just might improve the income earning experiences of rideshare drivers all over the U.S. As Uber and Lyft evolve their independent contractor agreements in California, the changes should rollout to other states in time.

~

See you next time!  

California's new gig economy law was meant to help workers. But it will likely hurt them instead

https://www.cnn.com/2020/01/09/perspectives/california-ab5/index.html

Assembly Bill 5 (AB5) and Independent Contractor Agreements in California