California’s ABC test for independent contractors presumes every worker is an employee unless the hiring business proves all three of the following: that the worker is free from the company’s control, that the worker’s tasks fall outside the company’s usual course of business, and that the worker independently operates a trade of the same kind. Miss any one prong, and the worker is legally an employee. The standard is codified at Labor Code Section 2775 and took effect January 1, 2020.1California Legislative Information. California Code Labor Code 2775 – Classification of Individuals as Employees or Independent Contractors
The burden falls entirely on the business. Two out of three does not pass.
Prong A: The Worker Is Free From Your Control
The worker must be free from the hiring business’s control over how the work gets done, both under the written contract and in day-to-day reality.1California Legislative Information. California Code Labor Code 2775 – Classification of Individuals as Employees or Independent Contractors This is where contracts and reality often diverge. A contract might say the worker sets their own schedule, but if the business actually dictates when, where, and how tasks get completed, the contract language is meaningless. Auditors and courts look at what happens on the ground, not what the paperwork claims.
Prong B: The Work Is Outside Your Usual Business
The worker must perform tasks outside the hiring business’s core operations.1California Legislative Information. California Code Labor Code 2775 – Classification of Individuals as Employees or Independent Contractors This is the prong that trips up the most businesses. A plumbing company cannot hire plumbers as independent contractors to do plumbing work for its customers. A software company cannot bring on contract programmers to build its main product. If the work is what the company sells, the worker is doing the company’s core business. The test does allow hiring contractors for genuinely ancillary tasks, such as an accounting firm hiring an electrician to rewire its office.
Prong C: The Worker Runs an Independent Business
The worker must already operate an independent business providing the same type of services.1California Legislative Information. California Code Labor Code 2775 – Classification of Individuals as Employees or Independent Contractors The person had a functioning business before the hiring relationship began and would continue to have one if it ended. Evidence that supports this includes a separate business location, their own equipment, publicly advertised services, and multiple clients. A worker who depends on a single company for all their income and has no independent client base will almost certainly fail this prong.
When the ABC Test Does Not Apply
Some relationships are evaluated under the older, multi-factor Borello standard instead of the ABC test.2California Department of Industrial Relations. Independent Contractor – FAQ Borello weighs the totality of the relationship: the business’s right to control how work is accomplished, whether the worker supplies their own tools, the length of the engagement, the method of payment, and the skill required. It is more flexible than the ABC test, but the business still has to prove the worker is a contractor.
Professional Services Exemptions
Labor Code Section 2778 lists specific professional categories that use Borello, provided certain statutory conditions are met.3California Legislative Information. California Code Labor Code 2778 These include licensed cosmetologists, barbers, and estheticians in salon settings; graphic designers; fine artists; grant writers; travel agents; enrolled agents licensed by the U.S. Treasury; freelance writers, editors, translators, and photographers; and payment processing agents, among others. Other exempt categories include licensed insurance agents, physicians and surgeons, lawyers, architects, engineers, private investigators, and accountants. For some professions, holding a valid license is itself a prerequisite for the exemption. The exemption is not automatic; the hiring business must still show that the additional statutory conditions are satisfied.
Business-to-Business Exemption
When one business hires another business (not an individual worker), Labor Code Section 2776 may apply, but the hiring business must satisfy all twelve statutory criteria.4California Legislative Information. California Code Labor Code 2776 Key requirements include a written contract specifying payment amount, services, and schedule; a separate business location for the service provider (a home office counts); freedom to contract with other businesses and public advertising of services; the provider’s own tools, vehicles, and equipment; a genuine ability to negotiate rates; and no requirement for a Contractors’ State License Board license. If even one of the twelve criteria is missing, the exemption fails and the ABC test applies. When all twelve are met, the relationship is evaluated under Borello.5California Labor and Workforce Development Agency. Business-to-Business Contracting Relationship Exemption
App-Based Drivers Under Proposition 22
Rideshare and delivery drivers working through platforms like Uber, Lyft, DoorDash, and Instacart operate under a separate framework. Proposition 22, passed by voters in November 2020, exempts app-based transportation and delivery companies from AB 5 and classifies their drivers as independent contractors, provided the companies meet specific conditions.6California Secretary of State. Proposition 22 – Text of Proposed Laws The platform cannot require drivers to work specific dates or minimum hours, cannot force drivers to accept particular ride or delivery requests, and cannot prevent drivers from working for competing platforms. In exchange, the law guarantees a minimum earnings floor of 120 percent of the applicable minimum wage for engaged time, plus a per-mile vehicle expense payment, and a healthcare subsidy for drivers who average 25 or more hours of engaged time per week. The California Supreme Court upheld Proposition 22 in 2024.
What Misclassification Costs
California enforces misclassification aggressively, and the penalties stack across state and federal agencies.
Labor Code Penalties
Under Labor Code Section 226.8, willfully misclassifying a worker as an independent contractor carries a civil penalty of $5,000 to $15,000 per violation. If the misclassification is part of a pattern or practice, the penalty jumps to $10,000 to $25,000 per violation.7California Legislative Information. California Code Labor Code 226.8 These are on top of any back wages, overtime, and benefits the worker should have received. A business that misclassified 20 workers in a pattern could face $200,000 to $500,000 in civil penalties alone, before unpaid wages.
EDD Tax Assessments
The Employment Development Department can assess unpaid unemployment insurance, disability insurance, and employment training taxes for misclassified workers, plus a 15 percent penalty on the assessed contributions for failure to file proper returns. If the misclassification involved fraud or intent to evade, an additional 50 percent penalty applies on top of the base assessment.8Employment Development Department. Penalty Reference Chart
Federal Tax Liability
Under Section 3509 of the Internal Revenue Code, an employer that misclassified workers and failed to withhold taxes owes 1.5 percent of wages for withholding tax plus 20 percent of what the employee’s Social Security tax would have been, if it at least filed 1099 forms. Without 1099s, those rates double to 3 percent and 40 percent.9Office of the Law Revision Counsel. 26 U.S. Code 3509 – Determination of Employer’s Liability for Certain Employment Taxes The reduced rates do not apply when the IRS determines the misclassification was intentional; in that case, the employer owes the full amount of employment taxes that should have been withheld and matched.
Documenting a Legitimate Contractor Relationship
If your business legitimately uses independent contractors, a strong paper trail is the best defense against a reclassification audit.
Start with a written contract that spells out the scope of work, the payment terms, and the independence of the contractor. The contract alone will not protect you if reality does not match, but not having one virtually guarantees problems. Beyond the contract, gather and keep evidence of the contractor’s independent business: their business license, professional certifications, federal Employer Identification Number, marketing materials, website, and proof they serve other clients. Copies of the contractor’s invoices to you and evidence of their own liability insurance further demonstrate a genuinely independent operation.
Issue Form 1099-NEC to each contractor paid $600 or more during the year and keep copies.10Internal Revenue Service. Instructions for Forms 1099-MISC and 1099-NEC The IRS requires businesses to retain employment tax records for at least four years after the tax becomes due or is paid, whichever is later.11Internal Revenue Service. Employment Tax Recordkeeping California’s statute of limitations for wage claims can extend to four years for written contract violations, so four years is a practical minimum.
Requesting a Formal Determination
If you are unsure about a worker’s status under California law, submit Form DE 1870 to the Employment Development Department to request a formal classification ruling. The form asks for detailed information about the services performed, the equipment used, and the degree of supervision involved.12Employment Development Department. Determination of Employment Work Status for Purposes of State of California Employment Taxes and Personal Income Tax Withholding Getting a ruling before an audit is far better than defending one during it. For federal purposes, the equivalent is IRS Form SS-8.13Internal Revenue Service. About Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding