California uses the “ABC test” to decide whether many workers are employees or independent contractors for purposes of the Labor Code, the Unemployment Insurance Code, and the state’s wage orders. Under the test, a worker is treated as an employee unless the hiring entity establishes all three conditions.
Where the ABC Test Comes From
The California Supreme Court adopted the ABC test in Dynamex Operations West, Inc. v. Superior Court (2018) 4 Cal.5th 903. In September 2019, the Legislature enacted Assembly Bill 5 (AB 5), which applied the ABC test for purposes of the Labor Code, the Unemployment Insurance Code, and the Industrial Welfare Commission wage orders. As later amended by AB 2257, the rules now appear in Labor Code sections 2775 through 2787.
The Three Conditions
According to the California Labor and Workforce Development Agency (LWDA), a worker is considered an employee, not an independent contractor, unless the hiring entity satisfies all three of these conditions:
A. Freedom from control. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract and in fact. A business does not need to control the precise manner or details of the work to have the kind of control an employer ordinarily has.
B. Work outside the usual course of business. The worker performs work that is outside the usual course of the hiring entity’s business. The examples drawn from Dynamex illustrate the line: a retail store that hires an outside plumber to repair a leak is not receiving services in its usual course of business, while a bakery that regularly hires cake decorators for its custom cakes is.
C. An independently established business. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed. The independent business must actually exist when the work is performed. Steps such as incorporation, licensure, advertising, and routinely offering services to the public tend to show an independent business. Labeling a worker an independent contractor, or requiring the worker to sign a contract saying so, is not enough.
The hiring entity has the burden on each part of the test. Failing any one of the three conditions means the worker is treated as an employee for the purposes the ABC test governs.
Exceptions and the Borello Test
The ABC test does not apply in every situation. For a number of occupations and relationships, the Labor Code applies instead the multifactor test from S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341, which focuses on the right to control the manner and means of the work along with other factors.
For some occupations, such as certain licensed physicians, dentists, attorneys, architects, engineers, accountants, insurance agents, and securities broker-dealers or investment advisers, the Borello test applies without further requirements. For others, including certain professional services contracts, bona fide business-to-business relationships, construction subcontractors, and referral agency arrangements, the Borello test applies only if specific statutory requirements are met first. App-based rideshare and delivery drivers are governed by Business and Professions Code section 7451, enacted by Proposition 22. Each exemption has its own detailed conditions.
Federal Tax Classification Uses a Different Test
For federal employment tax purposes, the IRS applies common-law rules that look at the degree of control and independence in three categories: behavioral control, financial control, and the type of relationship. According to the IRS, no single factor decides the question, and the whole relationship must be considered. Because the federal and California tests differ, the answer under one does not necessarily determine the answer under the other.
A business or worker can ask the IRS for a determination on Form SS-8, and the IRS offers a Voluntary Classification Settlement Program for businesses that want to prospectively reclassify workers as employees under specified terms.
Consequences of Misclassification
According to the LWDA, an employer that misclassifies workers may face liability for unpaid wages and overtime, unemployment insurance taxes, and workers’ compensation coverage, and may have to pay the employees’ share of payroll taxes, with penalties and interest. Under Labor Code section 226.8, willful misclassification can result in civil penalties of between $5,000 and $25,000 per violation. The EDD may also assess a penalty of 15 percent of the tax deficiency when misclassification results from negligent or intentional disregard of reporting and payment requirements. Federal employment taxes, penalties, and interest may also apply.
Reporting Payments to Independent Contractors
For federal purposes, the threshold for reporting payments on Forms 1099-NEC and 1099-MISC increased to $2,000 for tax years beginning after 2025, and it may be adjusted for inflation beginning in 2027. California separately requires a Report of Independent Contractor(s) (DE 542) to be filed with the EDD within 20 days in certain cases involving contractors who are individuals or sole proprietors; the EDD’s instructions set out when it applies.
Practical Steps
Businesses that use independent contractors in California often review each relationship against the ABC test or the specific exemption that may apply, confirm that the contractor operates an established independent business, make sure the actual working relationship matches the written agreement, and consider the federal common-law test separately.
The Bottom Line
In California, the ABC test makes employee status the default for most workers, and the hiring entity must prove all three conditions to treat a worker as an independent contractor unless a statutory exemption applies. Because the consequences reach wages, payroll taxes, and penalties, classification decisions are best made deliberately and documented.
Questions about worker classification?
Tax attorney Cassra Minai, Esq. can review your situation in a confidential consultation.