AB 5 for contractors: the ABC test and audit exposure

The default is employee, and the burden is yours

California does not ask whether you and a worker agreed the relationship was an independent contract. It asks whether you can prove it. Since Labor Code §2775 took effect on January 1, 2020, every person who performs labor or services for pay in California is presumed to be an employee, and the hiring entity carries the burden of proving otherwise. That statute codified the ABC test the California Supreme Court adopted in Dynamex Operations West, Inc. v. Superior Court (2018), and it applies for purposes of the Labor Code, the Unemployment Insurance Code, and the Industrial Welfare Commission wage orders — payroll tax, workers' compensation, wage-and-hour, and prevailing wage, all at once.

For a contractor who has always run a mix of W-2 crews and 1099 specialty subs, this is not a paperwork update. It is a shift in who has to make the case, and California has made that case hard to make.

The ABC test: three conjunctive prongs

To classify a worker as an independent contractor, the hiring entity must establish all three of the following. Failing any one prong makes the worker an employee as a matter of law.

• (A) Control. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under contract and in actual practice.
• (B) Outside the usual course of business. The worker performs work outside the usual course of the hiring entity's business. A framing crew a general contractor brings in to frame buildings almost never clears this prong — framing is the business.
• (C) Independently established trade. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed — evidenced by a license, a separate business location, other clients, and the ability to negotiate their own rate.

Where the exceptions sit, and why they don't rescue most crews

AB 5 and its 2020 amendment, AB 2257, carved out a defined list of occupations that revert to the older, multi-factor test from S.G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) instead of the ABC test — doctors, lawyers, accountants, and a defined category of business-to-business contracting relationships, among others. Construction has its own narrow path: a subcontractor has to be operating as a genuinely separate business — its own contractor's license under Business and Professions Code §7000 et seq. where one is required, its own business location, its own liability insurance, the ability to negotiate its own rate, and work that isn't performed exclusively for one general contractor.

None of that is presumed. A specialty sub who works only for you, uses your equipment, and takes assignments the way an employee takes a work order is an employee under either test — the Borello factors and the ABC test both weigh actual practice over what the contract says.

The contract you signed matters less than what happened on the jobsite. Both tests look at practice, not paper.

What misclassification actually costs

The exposure runs on two tracks that move independently of each other.

EDD payroll tax. The Employment Development Department audits off unemployment claims, referrals, and random selection. Reclassifying a worker as an employee retroactively means back unemployment insurance (UI) and employment training tax (ETT) contributions, unwithheld state disability insurance (SDI), and unremitted personal income tax withholding — plus interest, and penalties under the Unemployment Insurance Code for failure to withhold and failure to file.

Labor Code §226.8. Separately, willful misclassification carries its own civil penalty: not less than $5,000 and not more than $15,000 for each violation, rising to $10,000 to $25,000 per violation if the Labor Commissioner or a court finds a pattern or practice of willful misclassification. A person who advised the misclassification for pay — an accountant, a broker, a consultant — can be held jointly liable.

Why it bites harder on public work

On a private job, misclassification is a tax and wage-and-hour problem. On a public-works project it is also a prevailing-wage problem, because a misclassified worker doesn't get a certified-payroll line, doesn't count against an apprentice ratio, and doesn't get the fringe-benefit contribution the wage determination requires. An awarding body or the Labor Commissioner reviewing certified payroll under Labor Code §1776 isn't just checking your rates — they're checking whether everyone who touched the job is on the payroll in the first place. A crew paid as 1099 labor on a prevailing-wage job is functionally an unreported payroll, and that reads as a §1775 violation layered on top of a §226.8 one.

It can also affect DIR contractor registration standing under SB 854, and surface in a suspension or debarment referral if the pattern looks deliberate rather than mistaken.

What triggers a look

Audits rarely start from nowhere. The common openers:

• A former 1099 worker files for unemployment — the EDD claim itself asks whether the claimant was an employee, and a contested claim routinely turns into an audit.
• A workers'-compensation claim from someone with no W-2 on file.
• A competitor or union complaint to the Labor Commissioner or a Joint Enforcement Strike Force referral on the underground economy.
• A DIR public-works compliance review that can't reconcile the certified-payroll headcount with who was actually on site.

What holds up under review

If a relationship is a genuine independent contract, the file should already prove it before anyone asks:

• A written agreement describing a defined scope and deliverable, not ongoing hours.
• Evidence the worker has other clients and isn't economically dependent on you alone.
• A separate business license, contractor's license where required, and its own liability insurance.
• Invoices, not timesheets — payment tied to completed work, not hours worked.
• The worker's own tools, equipment, and crew, where the trade calls for them.

This article is educational and does not constitute legal or tax advice. Statutes and agency requirements change; confirm current rules with the California DIR, the U.S. Department of Labor, the IRS, or qualified counsel before relying on them. Aeternus Dynamics is a compliance and advisory firm, not a law or accounting firm.