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Consequences of California AB 2883 (Worker's Compensation Insurance Changes) to your Business and Taxes - The Excluded Employee

By Goria Weber & Jarvis on Feb 15, 2017 at 06:51 PM in San Diego Law Attorney News

For most active businesses with employees, you dutifully carry the required Worker's Compensation Insurance required by California Law. But just when you think you are doing all the right things, you may find you are in violation of new legislation that further expands required Workers Compensation insurance coverage for California businesses.

Prior to January 1, 2017, California law generally provided that officers, directors and managers of a business were exempt from coverage under the business' Workers' Compensation insurance requirements so long as the individuals were also owners of the business. But with the enactment of AB 2883, the California Legislature and Governor have determined they know more about business operations than you do.

Specifically, only employees who own at least 15% of the company are now exempt. Further, any employee who satisfies this 15% ownership requirement is exempt only if they execute a waiver under penalty of perjury that they meet these requirements. The waiver must further be accepted by the business' workers’ compensation insurance carrier. This means that working owners of a business who hold less than a 15% ownership interest are no longer exempt. 

For many business owners, this law change will result in significant additional costs for coverage where none was previously required. For example, those officers and directors of a corporation or the manager of an LLC may no longer be exempt from coverage if they own only a small portion of the entity.

In light of these possible costs, you may want to increase a shareholder or member's ownership interest in order to make them eligible for the waiver exemption. However, such ownership changes will obviously have both legal, business, and tax consequences for your business and to the owners of the business. We also believe AB2883 could have a significant impact on “start-up” businesses, which have been a very popular business model in California over the last 30 years, as AB 2883 creates one less reason to give employees a small ownership interest in a company.

From a legal standpoint, increasing a shareholder's ownership interest (issuing an ownership interest to an officer or director) has the potential to change the power structure, operations, and management of acompany. It may be beneficial to have shareholders execute a Shareholder Agreement providing for a bunch of "what ifs" that arise from the increased risk of conflict between owners, or updates to an LLC’s operating agreement.  The terms of such an agreements depend on the ownership composition, with a big factor being whether a single shareholder will be a majority owner. Also, while LLCs and partnerships may have slightly different procedures, the same analysis and agreements can be made to address their ownership composition..

Even in situations where a company desires to increase an employee’s ownership stake, the tax ramifications of issuing a shareholding or other ownership interests in a business must also to be addressed. For example, any stock issuance in exchange for less than fair market value consideration will be treated as ordinary income to him/her (and ordinary business expense to the corporation) depending on how the transaction is structured.

In light of this new AB 2883, we recommend you contact your insurance carrier to confirm your business' obligations under the new law. Please also feel free to contact our office anytime to discuss the consequences of California’s new edict on how we should run and operate our businesses.

Dave Jarvis

Meghan DeSpain