In California, workers are presumed to be employees unless the hiring entity proves otherwise. Misclassification can lead to liability and penalties including the obligation to pay back wages, unpaid overtime, legal fees, tax penalties, and costly litigation.
The ABC Test: California’s Default Rule
For many California wage-and-hour, Labor Code, and unemployment purposes, as well as unemployment insurance claims, the ABC test applies unless an exemption applies. To classify a worker as an independent contractor, the business must prove all three elements of the ABC test:
- Control: The worker is free from the company’s control and direction.
- Outside Usual Course of Business: The work performed is outside the company’s usual course of business.
- Independently Established Trade: The worker is customarily engaged in an independently established trade or occupation.
If the business cannot satisfy all three required elements, the worker is legally considered an employee.
Certain occupations (i.e. licensed professionals, direct salespersons, freelance creative workers, and others) are exempt from the ABC test and are evaluated under the Borello multi-factor test. This test focuses primarily on the right to control the manner and means of work, along with additional factors. Even professionals who serve multiple clients may be classified as employees depending on the specific facts. If the company retains the right to control how the work is performed, employee status is likely.
Federal law also applies. Under the Fair Labor Standards Act, worker classification turns on the “economic realities” test, which evaluates the totality of the relationship. Because California and federal standards differ, businesses should evaluate compliance under both frameworks.
Tax Treatment
Independent contractors are self-employed, paid via Form 1099-NEC, and responsible for self-employment taxes. Employees are paid via Form W-2 and are subject to income tax withholding and payroll taxes. Contracts and labels alone do not determine status. Agencies examine the substance of the relationship.
The Risk of Misclassification
Potential consequences include:
- Back wages and overtime
- Payroll tax liability
- Penalties and interest
- Class action claims
Engaging independent contractors can be beneficial when structured properly. If you are unsure about your workforce classification, a proactive review can help prevent costly disputes. Contact our office today to review your workforce structure and ensure compliance with California and federal laws.
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