Financial advisors are among the groups that could be most affected by proposed legislation in California and New Jersey that would heighten regulation of companies that hire independent contractors, according to industry observers.
The legislation is causing confusion among small businesses in California, and in New Jersey some independent contractors recently testified that it will derail their livelihoods. Reps at independent broker-dealers could be among those hit hardest, as could the growing number of clients in the gig economy.
California’s Assembly bill AB-5, which takes effect on January 1, requires business owners to either prove its workers are independent contractors or hire them as employees. New Jersey Senate bill S-4204, which expands the definition of employee versus independent contractor, was approved yesterday by the Senate Labor Committee and has advanced to the full state Senate. The Assembly has introduced a similar bill.
The legislation in both states was intended to make sure workers are fairly compensated—particularly as the gig economy expands. Challengers of the bills don’t dispute the importance of treating workers fairly, but they are worried about the ambiguity of the legislation and the economic pains it may cause.
“This bill would hit small businesses especially hard because they would be unable to use contractors for their non-essential tasks that large companies can do in-house, like payroll or janitorial services,” Mike Wallace, vice president of government affairs for the New Jersey Business and Industry Association, said in an article published on the NJBIA website about the NJ. legislation.
In an op-ed published in the Philadelphia Inquirer, N.J.-based freelance writer Jennifer Miller said that even if she was lucky enough to land a staff writer job, it would pay about half of what she is currently earning as a freelancer and that she would lose her flexibility. She also noted that her peers in California are already losing work in and out of state because of fears of similar legislation.
The California and New Jersey bills carve out exemptions for some careers, including real estate agents and accountants, but it’s not clear how it could impact people in other industries. According to the U.S. Department of Labor Statistics, there were 10.6 million independent contractors in May 2017, comprising 6.9% of total employment.
In addition to California and New Jersey, 11 other states have adopted the “ABC” test—the strictest test for defining independent contractor status.
The movement “feels like this is going to be gaining momentum, not losing it,” said Derek Holman, a managing director and co-founder of California-headquartered EP Wealth Advisors.
Holman said 20% to 25% of EP Wealth Advisors’ clients will be impacted by California’s AB-5. The bulk of these clients are business owners. He also has a number of other clients who retired from the defense industry and are now independently consulting for aerospace and defense companies.
Small business owners will have to hire lawyers and CPAs to figure out how to classify individuals they sometimes contract with for services for which they don’t require a built-out team of specialists, he said.
For example, a small business owner may occasionally hire a tech-savvy cousin to help with the company website, said Holman. The cousin may not pass all the tests that exclude him from being an employee, but under the California law “the presumption is that you’re an employee unless you can prove otherwise,” he said.
Although Holman thinks the intent of the law is correct, “classifying someone as an employee in California comes with a lot of hurdles and obstacles,” he said. Business owners have to make sure employees are complying with legally required lunch breaks, rest periods and overtime, he said. Yet someone consulting on a project might want to work more hours one day, especially if they’re juggling work for multiple businesses.
“Trying to fit people into the right employment box—especially in today’s world with technology making it so easy for people to work their own hours and respond to emails when they want—is not as easy as the clock-in, clock-out method that the employment laws are put around,” he said. “There’s potential liability for the employer,” he said, even if the employee is the one failing to comply with the legal mandates.
Business owners looking to avoid legal expenses and minimize their share of paying employment taxes and employee benefits might decide to stop working with relatives or other gray-area individuals and instead establish a relationship with a firm that clearly functions an independent contractor, said Holman.
Independent contractors who move into employee relationships should also consider the possible financial impact. Employers that hire them might pass along their added costs by reducing compensation, said Holman. The newly classified employees may also lose their ability to deduct business-related expenses, he said, and they may be more restricted on how much they can save in tax-deferred retirement plans.
Owners of SEP IRAs can contribute up to 20% of their annual income into these accounts, noted Holman. This may exceed the contribution limits for employer-sponsored 401(k) plans—$19,000 for 2019 and $19,500 for 2020 (plus catch-up contributions for workers over age 50).
Holman encouraged independent contractors to revaluate where they are financially and to take a close look at how they can reduce their debt and expenses. Expenses grow with income and sometimes “the fish get as large as the bowl,” he said.
Although Holman is concerned the legislation could have a largely negative financial impact on business owners and some independent contractors, he is hopeful the scrutiny it’s receiving will ultimately help business owners who’ve long been at risk of misclassifying workers amid a backdrop of ambiguous employment laws.
“There are so many different employment relationships that exist and so many versions, that it’s really hard to know if you’re classifying somebody correctly,” he said. “To the extent that this starts to clarify all the different scenarios, I think that would be positive.”