Effective January 1, 2020, California Assembly Bill 5 (“AB 5”), as amended, requires courts to apply an “ABC test” when determining whether a worker is an employee for purposes of the California Labor Code, California Industrial Welfare Commission Wage Orders (“Wage Orders”), and California Unemployment Insurance Code. Under the ABC test, a person is an employee by default, and not an independent contractor, unless the employer can demonstrate that:
- The person is free from the control and direction of the hiring entity in the performance of the work, both under the contract for the performance of the work and in fact;
- The person performs work that is outside the usual course of the hiring entity’s business; and
- The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
The law effectively codifies and expands upon the California Supreme Court’s 2018 decision in Dynamex Ops. W., Inc. v. Superior Ct., 416 P.3d 1 (Cal. 2018) (“Dynamex”). Prior to Dynamex, courts utilized the economic realities test set forth in S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 256 Cal. Rptr. 543 (Cal. 1989) (“Borello”) to make independent contractor determinations (See Exemptions to the ABC Test and The Economic Realities Test Applies to Exemptions, below).
As the ABC test was only recently changed from the economic realities test, there is little guidance from either the California legislature or the California Supreme Court on the three prongs. However, it is worth noting that while presenting limited substantive guidance, the California Supreme Court did make clear that the ABC test is intended to be stricter than the previously applied economic realities test set forth in Borello. The court held as follows:
The “A” prong (freedom from control and direction) is similar to the common-law test used in Borello, asking whether the person is free from the “type and degree of control a business typically exercises over employees.”
The “B” prong (outside the usual course of the business) focuses on whether the person is “providing services to the business in a role comparable to that of an employee, rather than in a role comparable to that of a traditional independent contractor.”
The “C” prong (independent trade, occupation, or business) asks whether the person “independently has made the decision to go into business for himself or herself,” evidenced by things such as “incorporation, licensure, advertisements, [or] routine offerings to provide the services of the independent business to the public or to a number of potential customers.”
Exemptions to the ABC Test
Certain occupations and contracting relationships are exempted from the ABC test. In such case, the economic realities test announced in Borello (discussed below) applies to these exemptions.
Exemptions to the ABC test are set forth California Labor Code §§ 2776 – 2784 and include:
- Contracts between a referral agency and a service provider, where a referral agency is defined as a business that connects clients with service providers that offer services that include, but are not limited to:
- Graphic design
- Youth sports coaching
- Wedding or event planning
- Services provided by wedding or event vendors
- Minor home repair and maintenance, including home cleaning, picture hanging, furniture assembly, pool cleaning, and yard cleanup
- Animal services, including dog walking and dog grooming
- Web design
- Interpretive services
- Contracts for professional services, which include:
- Human resource administration
- Travel agent services
- Graphic design
- Grant writing
- Fine art
- Services provided by an enrolled agent licensed by the U.S. Department of Treasury to practice before the Internal Revenue Service
- Services provided by a payment processing agent through an independent sales organization
- Services provided by a photographer, photojournalist, videographer, photo editor, or digital content aggregator provided that the individual providing services is not directly replacing an existing employee who performed the same work at the same volume for the hiring entity, and if the individual does not primarily perform the work at the hiring entity’s business location and the individual is not restricted from working for more than one hiring entity (this exception does not apply to a still photographer, photojournalist, videographer, or photo editor who works on motion pictures, including, but not limited to, theatrical or commercial productions, broadcast news, television, and music videos.)
- Services provided by a freelance writer, translator, editor, copy editor, illustrator, or newspaper cartoonist provided that the individual providing services is not directly replacing an existing employee who performed the same work at the same volume for the hiring entity, and if the individual does not primarily perform the work at the hiring entity’s business location and the individual is not restricted from working for more than one hiring entity
- Services provided by an individual as a content contributor, advisor, producer, narrator, or cartographer for a journal, book, periodical, evaluation, other publication or educational, academic, or instructional work in any format or media, who works under a written contract that specifies the rate of pay, intellectual property rights and obligation to pay by a defined time, who performed the same work at the same volume for the hiring entity, and if the individual does not primarily perform the work at the hiring entity’s business location and the individual is not restricted from working for more than one hiring entity
- Services from a licensed esthetician, electrologist, manicurist, barber, or cosmetologist provided that they satisfy certain conditions
- Services provided by a specialized performer hired by a performing arts company or organization to teach a master class for no more than one week
- Services provided by a licensed real estate appraiser
- Services provided by a registered professional forester
- Occupations in connection with the creation, marketing, promotion, or distribution of sound recordings or musical compositions, including (this exception does not apply to film and television unit production crews working on live or recorded performances for audiovisual works, including still photographers and cinematographers, or publicists who are not independent music publicists):
- Recording artists (that satisfy certain requirements)
- Songwriters, lyricists, composers, and proofers
- Managers of recording artist
- Record producers and directors
- Musical engineers and mixers
- Photographers working on recording photo shoots, album covers, and other press and publicity
- Independent radio promoters
- Any other individual engaged to provide creative, production, marketing, or independent music publicist services primarily related to the creation, marketing, promotion, or distribution of sound recordings or musical compositions
- Musicians or musical groups engaged for a single-engagement live performance event (that satisfy certain requirements)
- Individual performance artists (that satisfy certain requirements)
- Data aggregators (that satisfy certain requirements)
- Insurance brokers or persons who provide underwriting, inspections, premium audits, risk management, claims adjusting, third-party administration, or loss control work for the insurance and financial service industries
- Physicians, surgeons, dentists, podiatrists, psychologists, and veterinarians
- Licensed professionals (lawyers, architects, landscape architects, engineers, private investigators, and accountants)
- Securities broker-dealers and investment advisers
- Direct salespeople
- Commercial fishers
- Manufactured housing salespersons
- Construction subcontractors (that satisfy certain requirements)
- Newspaper distributors working under contract with a newspaper publisher and newspaper carriers working under contract with either a newspaper publisher or distributor (this provision becomes inoperative January 1, 2025 unless extended by the state legislature)
- Individuals engaged by international exchange visitor programs
- Competition judges with specialized skill sets providing services that require discretion and independent judgment for the purposes of determining the outcome or enforcing the rules of a competition, including, but not limited to amateur umpires or referees
- Individuals performing motor club services pursuant to a contract between a motor club and a third party to utilize the employees and vehicles of the third party to provide the services.
Note that real estate agents, home inspectors, and licensed repossession agencies are also exempt, but employee status is generally determined by the relevant portions of California’s Business and Professions Code rather than the economic realities test.
The Economic Realities Test Applies to Exemptions
As mentioned, exemptions to the ABC test apply the test set forth in Borello to determine worker classification.
The court in Borello considered the following factors comprising the “economic realities test” to determine employee status:
- The individual has the right to control the manner and means of accomplishing the work.
- The individual performing services is engaged in an occupation/business distinct from that of the principal.
- The services performed are not part of the regular business of the principal.
- The individual performing services supplies the instruments, tools, and place of work.
- The individual has invested in equipment, materials, and employees.
- Skill is required in the occupation of the individual performing services.
- The work is usually performed by a specialist without supervision.
- The individual’s managerial skills determine profit or loss for the individual’s business.
- The services are to be performed within a relatively short period.
- A low degree of permanence of the individual-principal relationship.
- Payment is by job or project, not by the hour.
- The parties do not believe they are creating an employer-employee relationship.
The economic realities test is similar to the common law control test established by prior precedent (see The Common Law Test below), except it places greater emphasis on an individual’s functioning as an independently organized business. That said, a specific criterion, standing alone, does not determine whether an individual is an independent contractor or an employee as a matter of economic reality. Rather, the relationship depends upon “the circumstances of the whole activity.”
The Common Law Test Applies in the Absence of an Applicable Statutory Provision
California courts and administrative agencies have traditionally applied the common law test of independent contractor status in cases where there is no applicable statutory provision.
The common law test was first articulated by the California Supreme Court in 1946 and takes into consideration the following factors to determine employee status:
Whether the one performing services is engaged in a distinct occupation or business
The kind of occupation, and particularly whether, in the locality, such work is usually done under the direction of the principal or by a specialist without supervision
The skill required in the particular occupation
Whether the principal or the worker supplies the instrumentalities, tools, and the place of work for the person doing the work
The length of time for which the services are to be performed
The method of payment, whether by the hour or by the job
Whether the work is a part of the regular business of the principal
Whether the parties believe they are creating the relationship of employer employee
Like the economic realities test, no one factor under the common law test is decisive, though the most important factor is the employer’s right to control the method and manner used to achieve the results desired. Thus, if the one to whom services are provided has the right to control the details of the work performance, regardless of whether the right is exercised, the person performing services will likely be deemed to be an employee.
Risks of Independent Contractor Misclassification
Establishing and maintaining defensible principal-independent contractor relationships in California can be difficult. As the legislature steadily expands the scope of statutory protections for employees, courts and administrative agencies have limited the number of individuals excluded from those protections. Moreover, the potential penalties imposed on employers who misclassify workers are significant.
California administrative agencies, particularly the Employment Development Department (EDD), scrutinize independent contractor relationships with increasing skepticism. Challenges to long-established relationships and practices can arise when workers file claims of employment discrimination or file claims for unemployment insurance benefits, unpaid wages, or workers’ compensation benefits. Allegations of worker misclassification may also arise when state investigators audit wage payments, workers’ compensation coverage, or unemployment insurance fund taxes.
If a court or state agency determines that an employer has misclassified an employee as an independent contractor, the employer can face significant tax, wage, and benefit liabilities, unanticipated tort liability to third parties for injuries caused by the worker, and wrongful discharge liability, as more particularly described below.
Wage and Hour Penalties
If workers classified and compensated as independent contractors are found to be employees, the employer may, among other things, face the following liability or penalties:
- Possible overtime pay, for a period of up to three years
- Back wages and other penalties, including $100 per underpaid employee pursuant to California Labor Code § 558
- For failure to timely pay all wages due and owing to a terminated employee, a penalty of up to 30 times the employee’s daily wage pursuant to California Labor Code § 203
- For failure to comply with timing and recordkeeping requirements, penalties equal to $100 for an initial violation and $200 per employee per pay period for each subsequent violation plus 25% of the wages unlawfully withheld pursuant to California Labor Code § 210
- For failure to provide itemized wage statements each pay period, penalties equal to $250 per employee for the first violation and $1,000 per employee for each subsequent violation pursuant to California Labor Code § 226.3
- For knowing and intentional violations of timing and recordkeeping obligations, an additional criminal (misdemeanor) penalty of up to $1,000 and/or one year of imprisonment pursuant to California Labor Code § 226.6
In addition, a non-willful misclassification of exempt or independent contractor status may cause decision-makers to incur personal liability. Any “person who acts on behalf of an employer” may be liable as the employer if he or she violates certain California wage and hour provisions. Note, a “person acting on behalf of an employer” refers to any natural person who is an owner, director, officer, or managing agent. The wage and hour consequences include the following items enumerated under California Labor Code § 558.1(a):
- Wage deductions pursuant to California Labor Code § 253
- Itemized wage statements pursuant to California Labor Code § 226
- Meal, rest, or recovery periods pursuant to California Labor Code § 226.7
- The state’s recovery of unpaid minimum wages or overtime pursuant to California Labor Code § 1193.6
- An employee’s recovery of unpaid minimum wages or overtime pursuant to California Labor Code § 1194
- Indemnification of an employee for expenditures or losses incurred because of the discharge of his or her duties or because of his or her obedience to the employer’s directions pursuant to § 2802
- Any order of the Industrial Welfare Commission regulating minimum wages or hours (see California Code of Regulations, title 8, § 11000 et seq.)
Workers’ Compensation Penalties
If workers classified as independent contractors for whom the employer did not obtain workers’ compensation coverage are found to be employees, the employer may, among other things, face the following civil liability and/or penalties:
- Civil tort liability for injuries to misclassified worker
- Civil tort liability for injuries to a third party caused by the misclassified worker’s negligent acts, committed in the course and scope of employment
- A penalty of up to 10% of any workers’ compensation benefits recoverable by a misclassified worker
- A penalty of up to $100,000 payable to the state
- Tax and Benefits-Related Penalties
If workers classified as independent contractors are found to be employees, the employer may be assessed amounts due for, among other things, the following:
- State income tax not withheld, unless the employer can show that the worker appropriately reported income and paid state income taxes due
- Fine of up to $1,000 and/or sentence of up to one year in prison for failure to make appropriate withholdings for state income tax payments from employee paychecks
- Unemployment insurance taxes, ranging between 1.5% and 6% on the first $7,000 paid to the worker in the calendar year, depending upon the employer’s contribution (tax) rate
- Employment training taxes
- Short-term disability insurance taxes (see California Revenue & Taxation Code § 19521)
- Potential negligence penalty and interest on any unpaid taxes
Penalties for Willful Violations
In addition to the consequences identified above, California imposes harsh penalties if the employer is found to have engaged in “willful misclassification” of employees. “Willful misclassification” of a worker means “voluntarily and knowingly” misclassifying that worker as an independent contractor to avoid employee status for the worker. The penalty is a minimum of $5,000 and capped at $15,000 per violation. If the entity is found to have a “pattern or practice” of misclassification, the fines can be increased to a minimum of $10,000 and capped at $25,000 per violation. The law also requires a one-year public prominent posting (on a website or at a worksite) of notice that the entity was found to have willfully misclassified an independent contractor.
In addition to other available remedies, the California Attorney General, district attorney, city attorney, or city prosecutor may bring an action for injunctive relief against an employer that misclassifies employees as independent contractors to prevent their continued misclassification.