How do I classify workers as employees vs. independent contractors under California AB5?
Under California AB5, every worker is presumed to be an employee. It’s on you as the hiring business to prove otherwise. This is the opposite of how most business owners think about it. You don’t get to decide someone is a contractor just because you pay them per job or they signed a 1099 agreement. California requires you to pass all three prongs of the ABC test, and failing even one means the worker is legally your employee.
Prong A asks whether the worker is free from your control and direction, both in their contract and in practice. If you set their schedule, tell them how to do the work, or require them to use your equipment, you’re exercising control. Prong C asks whether the worker has an independently established trade, occupation, or business of the same nature as the work they perform for you. Do they have their own business license, other clients, and their own tools? If they only work for you, this prong is hard to satisfy.
Prong B is where most businesses get stuck. You must prove that the worker performs work outside the usual course of your business. A trucking company hiring drivers can’t pass this test because hauling freight is exactly what the company does. A restaurant hiring cooks fails for the same reason. A salon bringing in stylists to cut hair in their chairs has the same problem. If the person’s work is core to what your business does, Prong B won’t work in your favor. This is why companies in freight and logistics have had to reclassify so many of their drivers as W-2 employees.
The consequences of getting this wrong are significant. California’s EDD can audit your business and reclassify your contractors as employees retroactively. That means you owe back payroll taxes, unemployment insurance contributions, penalties, and interest. Workers can also file claims for unpaid overtime, missed meal breaks, and benefits they should have received. In some cases, misclassification can lead to penalties of $5,000 to $25,000 per violation.
There are some exemptions built into AB5 for specific professions like licensed insurance agents, certain healthcare professionals, and business-to-business relationships that meet a separate set of criteria. But these exemptions are narrow and come with their own requirements that must be documented carefully.
From a bookkeeping standpoint, proper classification affects everything. Employees require payroll tax withholding, workers’ comp coverage, and quarterly filings. Contractors get 1099s at year end. If you’ve been paying someone as a contractor and they should be an employee, your books need to reflect that change going forward and you may need to correct prior periods.
The practical takeaway for California business owners is to start from the assumption that your workers are employees and only classify someone as an independent contractor if you can clearly pass all three prongs. Document your reasoning. If you do have legitimate contractors, make sure you’re issuing 1099s and keeping clean records of the relationship.
If you’re unsure about your current setup, working with bookkeepers in Buena Park who understand California payroll requirements can help you get your worker classifications and payroll right before it becomes a problem.
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