On January 1, 2020, a new law went into effect in California that re-classifies many independent contractors as employees. California Assembly Bill 5 in combination with CA Labor Code 2802 could mean that your company must now reimburse contractors for their vehicle expenses.
What is California Assembly Bill 5?
On September 18, 2019, California Governor Gavin Newsom signed a bill designed to codify a previous court decision relating to the definition of "independent contractor vs. employee." California Assembly Bill 5 (AB 5), which went into effect January 1, 2020, created a new three-part test based on the CA Supreme Court's decision in the case Dynamex Operations West, Inc. vs. Superior Court of Los Angeles.
Under the Dynamex ABC test, a contractor who does not meet all of the following three criteria must now be considered an employee.
- The worker is free from control of the hiring entity in the performance of work.
- The worker performs duties outside the normal business of the hiring entity.
- The worker already engages in the same type of work as an independent trade or for other businesses.
While there are a number of exceptions, such as for physicians, lawyers, engineers, and freelance writers, a large number of workers in California must now be treated as employees not only for the purposes of wages but business reimbursements as well.
How does California AB 5 affect vehicle reimbursements?
If your company employs independent contractors who must operate vehicles as part of their work, you may now be responsible to reimburse them for vehicle expenses. CA Labor Code, Section 2802(a) already requires businesses to reimburse California employees for "all reasonable costs" incurred while conducting duties on behalf of the employer. These costs include the expense of both owning and operating a vehicle.
Now that most independent contractors are now considered employees, it follows that the companies for which they work must reimburse them for the same business expenses covered under Section 2802 of the labor code.
In fact, the reimbursement of vehicle expenses factored heavily in the original Dynamex class action suit that triggered the new law. In 2004, Dynamex, a same-day courier and delivery service, re-classified its drivers as independent contractors instead of employees. They were now responsible to cover their own vehicle expenses, such as fuel, maintenance, insurance, tolls, and more.
When two drivers sued the company, alleging that they were wrongly classified as contractors, the California Supreme Court sided with them, resulting in what's now called the Dynamex ABC test – the three-part test now added by Assembly Bill 5 to the California labor code.
How to comply with AB 5 and California reimbursement law
Here are three steps your company should take in response to Assembly Bill 5 if you operate in the state of California.
1. Determine whether your contractors are now employees.
If your company currently has independent contractors, it is imperative that you determine whether they are now considered employees under California law. Seeking legal counsel may be necessary to make these determinations, especially with the many exemptions in place and a spate of lawsuits seeking further clarification of the law.
2. Ensure full vehicle reimbursement for all CA employees.
If your contractors operate a personal vehicle for work, you will likely need to begin reimbursing them fully for that vehicle, along with other business expenses. If you have any employees that are not being reimbursed for business vehicle expenses, then you need to reimburse them in order to comply with CA Labor Code 2802. That will apply to any contractors now re-classified as employees.
3. Adopt a vehicle reimbursement method that complies with CA Labor Code 2802(a).
Choosing an appropriate vehicle reimbursement method can be a challenge. To comply with California labor law, you need a quantifiable reimbursement method that you can prove covers all employee vehicle costs. Let's look at two options: reimbursement using the IRS mileage rate and FAVR reimbursement.
What's the best way to reimburse California employees for their vehicles?
Many California employers use the IRS standard business mileage rate to reimburse employees for the use of personal vehicles. The IRS business rate for 2020 is 57.5 cents per mile. This rate has generally been considered compliant with the labor code.
However, a number of problems exist with reimbursements using the IRS standard rate (aka the federal rate). For an in-depth analysis, read Employers Are Questioning the IRS Mileage Rate and Top 3 Reasons NOT to Use the IRS Mileage Rate.
Here is a summary of the problems with using the IRS rate for California vehicle reimbursements:
- The IRS mileage rate represents an average of U.S. vehicle costs for the previous year, yet California drivers experience much higher than average costs, making it insufficient for some CA drivers.
- The IRS rate as a mileage reimbursement will tend to over-reimburse high mileage drivers and under-reimburse low mileage drivers.
- In the long run, paying the IRS mileage rate to employees tends to create uncontrollable costs as drivers drive more to increase their pay.
Let's look at the best alternative: FAVR reimbursement.
Using FAVR reimbursement to comply with California's AB 5
We recommend using the fixed and variable rate reimbursement to comply with the combination of California Assembly Bill 5 and Labor Code 2802. This approach to vehicle reimbursement tailors the reimbursements to specific employees using vehicle expense data relative to their geographic location – perfect for a state with volatile costs like California.
To learn more about this transparent, defensible, and geographically-sensitive reimbursement method, read our guide to FAVR reimbursement.