Employee vs. Independent Contractor in California (AB 5)

Hiring · California law

Employee or contractor? Pass all three

California presumes every worker is an employee. Here is how the AB 5 ABC test works, where the exceptions are, and what misclassification costs.

3 prongsAll must be met under the ABC test

$25,000Top civil penalty per violation

2,020Year AB 5 took effect

The question of employee vs independent contractor decides who pays payroll taxes, who gets minimum wage, overtime, sick leave and workers’ compensation, and who carries the risk when something goes wrong. In California the answer starts from a presumption: a person you pay for labor or services is an employee unless your business can prove otherwise. Since Jan. 1, 2020, Assembly Bill 5 (AB 5) has set out how to prove it.

This guide draws on the Department of Industrial Relations (DIR) independent contractor FAQ, the Labor and Workforce Development Agency’s Employment Status Portal, the EDD’s California Employer’s Guide 2026 and the IRS, all checked Nov. 13, 2026. Classification turns on facts, so treat this as a map, not legal advice, and get a written ruling or an attorney’s opinion for close calls.

How California got here

In 2018, the California Supreme Court adopted the ABC test in Dynamex Operations West, Inc. v. Superior Court. The Legislature wrote that test into law with AB 5, which the governor signed in September 2019 and which took effect Jan. 1, 2020. AB 5 applies the ABC test to the Labor Code, the Unemployment Insurance Code and the Industrial Welfare Commission wage orders. AB 2257 later amended it, and certain app-based drivers are covered by Proposition 22 instead.

The ABC test, one prong at a time

Under the test, a worker is an employee unless the hiring business shows that all three of these are true. Failing any one prong makes the worker an employee.

The state’s own examples

• Prong A, failed: home-based knitters and sewers working from a company’s patterns. Working at home does not change the company’s control over production.
• Prong A, met: a historic reconstruction specialist who set his own schedule, worked unsupervised and bought materials on his own business credit card.
• Prong B, met: a retail store that hires an outside plumber or electrician to repair or install something on its premises.
• Prong B, failed: a bakery that hires cake decorators to work on its custom cakes, the same work its employees do.
• Prong C, failed: a taxi driver whose city permit could only be used while working for one company. A contract that calls someone a contractor does not satisfy Prong C on its own.

Where the Borello test still applies

AB 5 did not sweep every relationship into the ABC test. For listed occupations and arrangements, California uses the older Borello test from S.G. Borello and Sons, Inc. v. Department of Industrial Relations (1989). Borello weighs many factors, and the most important is whether the hiring business has the right to control how the work is done. No single factor decides the case.

One exemption small businesses use often is the bona fide business-to-business relationship. If every requirement in the statute is met, the DIR says Borello applies instead of the ABC test. The conditions are detailed, and every one must be met. Review each one in the DIR FAQ and the statute, and keep the proof in writing before relying on the exemption.

The federal test is different

The IRS uses its own common-law test, built on three categories of evidence: behavioral control (do you control what the worker does and how), financial control (who controls the business side, such as how the worker is paid, expenses and tools) and the type of relationship (contracts, benefits, how long it lasts and whether the work is a key part of your business). The IRS looks at the whole relationship, and no single factor decides it.

Because the tests differ, a worker can be a contractor for federal tax purposes and still an employee under California law. The EDD warns that California does not offer the relief available under the federal safe harbor rules, so state classification has to stand on its own.

• Form SS-8. Either the business or the worker can ask the IRS for a status determination; the IRS says it may take at least six months.
• Voluntary Classification Settlement Program. Businesses can reclassify workers as employees going forward with partial relief from federal employment taxes by filing Form 8952.
• Form 8919. A misclassified worker can use it to report the employee share of Social Security and Medicare that was never withheld.

What misclassification costs

The costs stack up from several agencies at once. Under Labor Code section 226.8, willfully misclassifying an employee as an independent contractor, meaning doing it voluntarily and knowingly, carries civil penalties of $5,000 to $25,000 per violation, according to the DIR. Separate penalties apply for the wage violations that usually come with it.

• Back wages. Minimum wage, overtime, meal and rest period pay, and paid sick leave the worker should have received.
• Payroll taxes. Unemployment Insurance, SDI, the employee share of payroll taxes you failed to withhold, and interest. The DIR notes the EDD can add a penalty of 15% of the deficiency when misclassification reflects negligent or intentional disregard of the law.
• Workers’ compensation. The Labor Commissioner presumes a worker is an employee under Labor Code section 3357, and an uninsured employer faces a stop order and a penalty of at least $1,500 per employee.
• Headcount rules. Contractors count toward the five-worker threshold for California’s harassment prevention training requirement.

Paying contractors the right way

When the relationship truly is independent, document it and report it. California requires the Report of Independent Contractor(s), DE 542, within 20 days of paying a contractor $600 or more or signing a contract for $600 or more, whichever comes first. On the federal side, IRS Publication 15 says Form 1099-NEC is required for payments of $2,000 or more made in 2026, up from $600. Collect a Form W-9 before the first payment.

If you work as a contractor yourself, our side hustle taxes guide and quarterly estimated taxes guide explain the self-employment side. If the answer is employee, our guide to hiring your first employee in California lists every step, and the solopreneur guide covers when to hire and when to outsource.

Common mistakes

• Relying on the contract label. Calling someone a contractor does not make them one.
• Hiring contractors for core work. If the work is what your business sells, Prong B is hard to meet.
• Converting an employee into a contractor. Same person, same job, new paperwork is a red flag.
• Using only the IRS test. California applies the ABC test and offers no federal safe harbor relief.
• Skipping the DE 542. California still wants contractor reports at $600, even with the new $2,000 federal 1099 threshold.

Key terms

• ABC test: California’s three-part test; a worker is an employee unless all three parts are proven.
• AB 5: the 2019 law, effective Jan. 1, 2020, that put the ABC test into the Labor Code, Unemployment Insurance Code and wage orders.
• Borello test: the multifactor control test from a 1989 California Supreme Court case, still used for exempt occupations and relationships.
• Misclassification: treating an employee as an independent contractor.
• Form SS-8: the IRS form to request an official worker status determination.

The bottom line: in the employee vs independent contractor question, California starts by assuming “employee.” Before you pay someone on a 1099, confirm all three ABC prongs, check whether a Borello exemption truly applies, keep the evidence in writing and file the DE 542. When in doubt, ask the EDD for a written determination; it costs far less than penalties of up to $25,000 per violation.

Free help in the Sacramento region

You do not have to work through these decisions alone. SCORE Sacramento pairs owners with volunteer mentors, many of them retired executives, bankers and accountants, at no cost. The Sacramento Valley Small Business Development Center offers free one-on-one advising on financing, budgeting and financial statements. The SBA’s Sacramento District Office can explain loan programs and connect you with lenders, and community lenders such as California Capital and Opening Doors serve owners who need smaller loans or extra support. Browse our Business Resources and the free business help guide for more.

Frequently asked questions

Sources

• California DIR: Independent Contractor versus Employee FAQ
• California Labor and Workforce Development Agency: ABC Test (Employment Status Portal)
• California Labor and Workforce Development Agency: Employment Status Portal for Employers
• EDD: California Employer’s Guide 2026 (DE 44)
• IRS: Independent Contractor (Self-Employed) or Employee?
• IRS Publication 15 (Circular E), Employer’s Tax Guide (2026)
• California Labor Commissioner: Workers’ Compensation Insurance FAQ
• California Civil Rights Department: Sexual Harassment Prevention Training, Information for Employers (FAQ)