Independent Contractor vs. Employee in California: The ABC Test

California uses a stricter test than many states to decide whether a worker is an employee or an independent contractor. Calling someone a contractor in the agreement doesn't settle it.

The ABC test

Under Labor Code § 2775 — enacted by AB 5 and based on the California Supreme Court's Dynamex decision — a person providing labor or services for pay is considered an employee unless the hiring entity shows all three of the following:

1. A — Free from control. The worker is free from the hiring entity's control and direction in performing the work, both under the contract and in fact.
2. B — Outside the usual course of business. The work is outside the usual course of the hiring entity's business.
3. C — Independently established business. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Prong B trips up many businesses: a contractor doing the same core work as your employees will likely be treated as working in your usual course of business.

Exemptions

The Labor Code lists exemptions for certain occupations and relationships — for example, specified professional services (§ 2778) and qualifying business-to-business relationships (§ 2776). Each exemption has detailed conditions. Where one applies, classification is generally decided under the older multi-factor Borello test instead.

Federal rules are different

The IRS uses its own common-law test for federal tax purposes, which looks at behavioral control, financial control, and the relationship of the parties. A worker can be a contractor under one test and an employee under another.

Why it matters

Misclassification can lead to liability for wages, overtime, expense reimbursement, payroll taxes, and penalties. Labor Code § 226.8 provides civil penalties for willful misclassification of $5,000 to $15,000 per violation, and $10,000 to $25,000 per violation for a pattern or practice.

Practical steps

• List each contractor and what they actually do day to day.
• Test each relationship against all three ABC prongs — and any exemption that might apply.
• Use written agreements that match reality, including IP assignment and confidentiality terms.
• Where the analysis points to employment, plan the transition with your payroll provider and advisors.

Sources

1. Labor & Workforce Development Agency — ABC test
2. Cal. Labor Code § 2775 (ABC test)
3. Cal. Labor Code § 2776 (business-to-business exemption)
4. Cal. Labor Code § 2778 (professional services exemption)
5. Cal. Labor Code § 226.8 (willful misclassification)
6. EDD — Employee or independent contractor
7. IRS — Independent contractor (self-employed) or employee?