California recently passed a bill (Assembly Bill 5), which required that certain companies, such as ridesharing and food-delivery companies, must hire workers as employees instead of independent contractors. The bill, which received some pushback from the two largest ridesharing companies, Lyft and Uber, is intended to provide workers with basic labor rights, employee benefits and the ability to form a union.
Weeks after the law will go into effect on January 1, workers in other industries that employ freelancers and independent contractors are confused as to how the bill will affect them, and hope to receive clarification soon.
AB 5 Backlash
Amidst chaos and confusion, one thing is certain: many major companies the bill will affect aren’t happy. Uber, Lyft and other ride-hailing and on-demand companies within the gig economy have put together over $100 million on a ballot initiative to exempt them from Assembly Bill 5, stating that the bill could force them to raise prices and make changes that will take away from the flexibility of the driver’s schedule.
Back in October, Tony West, Uber’s chief legal officer stated that the bill will create a “real game changer” within the industry as new changes will be implemented in accordance with AB 5. West went on to say that he believes the changes will be unwelcome among most drivers.
But drivers aren’t the only workers displeased with the change. In a recent Wall Street Journal article, Avo Soltanian, a practicing lawyer in Glendale is unsure whether the AB 5 exemption applies to his practice. If his practice is not exempted, he will have to reclassify four licensed therapists who work under him as part-time employees rather than contractors in a group practice, which he guesses will add up to 20% to his costs. While some contract workers welcome the change, many are like Avo Soltanian, who are confused as to what the new bill will bring, and fear it will cut into his profits.
Not Eligible for the Solo 401(k)
The Solo 401(k) is a self-directed retirement plan and the most robust plan for self-employed individuals, including freelancers and those within the gig economy. One of the eligibility requirements of establishing this plan is to generate some form of self-employment income. However, with the new Assembly Bill 5, many workers within the gig economy will be reclassified as employees, therefore will no longer be able to establish the Solo 401(k) plan.
This means they will not be able to receive the many benefits built into the plan, which include:
- Tax-Free Loan Option: Borrow up to $50,000 or 50% of your account value (whichever is less) to use for any purpose.
- Easy Administration: There is no annual tax filing or information returns for a plan that does not exceed $250,000 in assets.
- No need to establish an LLC: LLCs can be costly, especially depending on which state you live in. With a Solo 401(k), the trustee (you) can make investments without the need of an LLC.
- Strong Creditor Protection: Most states offer better creditor protection for this retirement plan than a Traditional IRA. Additionally, Individual 401(k) Plan assets are protected against creditor attack in a bankruptcy proceeding.
- Roth After-Tax Benefit: You have two formats with a Solo 401(k): pre-tax, or Roth (after-tax). With a Traditional IRA, you only have the option of pre-tax. With the Roth option, your money can grow in its retirement account tax-free. And of course, when you withdraw at retirement, you pay no additional taxes.
- Non-recourse Leverage Exception: You can invest in your own business and real estate investments without penalty. By using non-recourse funds, you won’t trigger the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBTI and UBIT). This exception doesn’t apply to IRAs.
The future for many workers within the gig economy is still unclear, but with any luck, the courts will soon bring clarity to the situation. Especially since other states, including New York, are interested in implementing a similar legislation.
If AB 5 will affect your classification and ability to establish the Solo 401(k), review a few side gigs anyone can do to become eligible.