California Contractor vs Employee: ABC Test for 1099 Workers

What is California's ABC test for contractor vs employee, and who must prove it?

California presumes that a person paid for work is an employee. The ABC test comes from the 2018 Dynamex court decision, and AB 5 wrote it into the Labor Code (sections 2775 to 2787) (Labor Commissioner FAQ). To treat the worker as an independent contractor, the hiring business must prove all three conditions below; failing any one makes the worker an employee (EDD: employment status; Labor Commissioner FAQ). The burden is on the business, not the worker. Part-time, temporary and casual workers can be employees too (EDD: DE 231).

Part B is where many 1099 workers fail: someone who does the work your business sells, or a role like your employees', is likely inside your usual course of business. A case is not simple when several people work like staff on 1099s, when Part B is in doubt, when the same people have been paid on 1099s for several years, when an exception might apply, or when the EDD or a worker has already raised the question. Gather for each worker: the contract, invoices, start date and total paid by year, who sets hours and methods, tools used, other clients, and the worker's license, insurance and advertising.

Does a 1099, a written agreement or the worker's own LLC make someone a contractor?

No. A contractor label, a signed agreement saying so, and payment on a Form 1099 without withholding do not decide status, and a business cannot turn an employee into a contractor with an agreement or a 1099 (Labor Commissioner FAQ).

A worker's own LLC or corporation helps with Part C, because incorporation and licensing are typical steps of an independent business. It says nothing about Parts A and B. The business-to-business exception below can reach a worker who operates through an entity, but only if every one of its requirements is met (Labor Commissioner FAQ).

Which agencies and taxes use the ABC test?

The EDD (payroll taxes), wage and hour law and workers' compensation all use the ABC test, from different start dates (Labor Commissioner FAQ).

The EDD can decide a worker's status through an employment tax audit or while deciding the worker's claim for unemployment or disability benefits (Labor Commissioner FAQ). Registering and the four state payroll taxes are in California payroll setup.

Which workers are exempt from the ABC test?

Some occupations and relationships use Borello, a court test that weighs many factors, instead of the ABC test, and a few use other statutes. Each exception has its own conditions, which the Labor Commissioner calls complicated and says to take advice on for a specific case (Labor Commissioner FAQ).

Borello does not lift the burden: both tests start from the assumption that the worker is an employee. Borello weighs many factors, none controlling, such as control over the manner and means of the work, who supplies tools and the worker's opportunity for profit or loss (Labor Commissioner FAQ; EDD: DE 231).

For unemployment insurance, training tax and disability insurance, passing a test does not always settle it: the Unemployment Insurance Code also names some workers as employees, such as corporate officers, certain commission drivers and salespeople, certain home workers who return finished goods, members of an LLC taxed as a corporation, and an unlicensed worker or subcontractor hired for work that needs a contractor's license, whose hirer is the employer. The code also excludes some work from these three taxes, such as a sole proprietor's or partnership's spouse or registered domestic partner, parent or child under 18, though that pay still carries income tax withholding (EDD: DE 231).

Business-to-business exception. All of the following must be true (Labor Commissioner FAQ):

• The worker is a sole proprietor or a partnership, LLC, LLP or corporation, with a written contract stating the payment amount and due date.
• The worker is free from the business's control under the contract and in fact and can negotiate its own rates. Consistent with the nature of the work, it sets its own hours and location and uses its own tools.
• The worker has a separate business location, holds any required business license, advertises to the public, and can serve other businesses without restriction.
• The worker serves the hiring business directly (subject to a stated exception), is customarily engaged in an independent business of the same kind, and does no work that needs a Contractors State License Board license.

Can a worker be an independent contractor for the IRS but an employee in California?

Yes. California can treat a worker as an employee even if federal law does not, because the tests differ (Labor Commissioner FAQ). A 1099 that holds up federally settles nothing in California. The federal test, section 530 relief and fixing past federal filings are in contractors who may be employees.

The EDD makes employment tax audit information available to the IRS under an exchange agreement (EDD: DE 231TA).

What does misclassifying a worker in California cost?

Misclassification can bring back payroll taxes, penalties, interest, unpaid minimum wage and overtime, and workers' compensation liability; the amounts depend on the years and facts (Labor Commissioner FAQ).

How far back the EDD can go. An EDD audit generally covers three years, the 12 most recently completed calendar quarters, and can reach beyond it (EDD: DE 231TA). The assessment time limit depends on what was filed (EDD: DE 40): generally three years when a return was filed but understated wages; up to eight years when no return was filed and there was no good cause; no limit for fraud or intent to evade. An employer can sign a waiver or extension of these limits (form DE 1977), which lengthens its own exposure.

What an employee costs against a contractor is in cost of an employee vs a contractor; missed deposits and returns are in behind on payroll taxes.

I use 1099 workers in California: how do I check each one?

Test each worker separately, on facts you can document. A worker the business cannot show to meet all three parts is an employee, and one failed part is enough (Labor Commissioner FAQ).

1. List everyone paid for services in California, including people paid in cash or by app, with start date, work done and total paid each year. Tie the list to your bank statements, general ledger, the Forms 1099 you filed, and the invoices and agreements; an EDD audit asks for those records (EDD: DE 231TA).
2. Check whether an exception could apply, and if so test every condition of it in writing.
3. Otherwise test Parts A, B and C one at a time against the evidence listed in the first section, and keep one file per worker.
4. Decide. If the answer is employee, plan the move to payroll. If it is unclear, the EDD offers a written determination; read the cautions in the next section first.

The EDD's own request form (DE 1870) asks for these facts about a worker: helpers, other clients, who supplied tools, advertising, licenses, training, instructions, required reports, and who set the schedule, the pay and the methods (EDD: DE 1870). Once workers are employees, see California payroll setup.

How do I ask the EDD for a determination?

Send Form DE 1870, and the EDD answers in writing within 60 days of receiving the request (EDD: DE 231ES). The answer is a ruling letter, an official document that may be used to resolve future issues. The form covers unemployment insurance, employment training tax, state disability insurance and personal income tax withholding, not wage and hour law or workers' compensation (EDD: DE 1870).

• Complete one form for one worker who represents a class. The determination applies to other workers of the same class if the facts are the same; a separate class needs its own form.
• The ruling rests on the facts presented. It is not valid if facts were omitted or misrepresented, and it no longer applies if the facts change.
• The EDD will not issue a ruling while an audit or investigation involving you or the workers is open, while the identical issue is in litigation or before the Unemployment Insurance Appeals Board, or for a hypothetical situation.
• The form asks for dates of service and workers' names and contact details, and the EDD may contact you or some of your workers.

The EDD forms DE 1870 and DE 231ES were last revised in 2018 and 2013, before the ABC test took effect for the EDD, so confirm the EDD's current process before sending. Because the request names the workers and the dates they worked, settle how a ruling would affect quarters already paid before you file it.

What if the EDD sends a letter or audits me, or a worker files a claim?

An audit, an assessment and a petition run on short deadlines, so a letter or a worker's claim is the point to bring in a professional before you answer. Note the response date on the letter, collect the records, and work out which periods and workers are involved. An EDD audit starts with a test year, usually the latest completed calendar year, and asks for your books, bank records, income tax returns and Forms 1099, plus invoices and written agreements when status is in question. The auditor asks why you believe each worker is a contractor, explains the factors in a closing meeting (the exit interview), and, when the audit ends in an assessment, offers a pre-assessment conference with a supervisor (EDD: DE 231TA; EDD: DE 40). DE 231TA was last revised in 2018 and still names the common law test; the EDD's audit guidelines apply the ABC test (EDD: DE 40).

An ordinary Notice of Assessment, the EDD's written notice of the amount it says you owe, becomes final 30 days after service unless you file a petition for reassessment, which goes to the California Unemployment Insurance Appeals Board for a hearing before an administrative law judge, who can allow the same time again for good cause. If you neither pay nor petition by the final date, a further 15% of the unpaid contributions is added, and the EDD cannot waive it. A jeopardy assessment, which the EDD may issue on specific findings such as insolvency, hidden assets or a fraud penalty, is final at once and stays immediately due and payable; its petition is due within 10 working days, and the same further penalty applies if it is not paid, or secured, within 30 days of service (EDD: DE 231TA; EDD: DE 40).

If the EDD assesses personal income tax that was never withheld, the employer must start the abatement process itself, either by declaring on form DE 6028P that it filed Forms 1099 or W-2 on time, or by collecting worker certifications on form DE 938P that the tax was paid. Penalties stay and interest is only partly reduced (EDD: DE 40).

A worker who thinks they were misclassified can file a wage claim with the Labor Commissioner, a report of labor law violation for widespread problems, or a lawsuit. A worker who is fired or otherwise retaliated against for raising it can file a retaliation complaint with the Labor Commissioner (Labor Commissioner FAQ). A wage claim, retaliation complaint or lawsuit is a legal dispute: bring in an employment lawyer, and have your books and pay records ready.

What must I report to the EDD for contractors I keep?

File a Report of Independent Contractor(s), form DE 542, within 20 calendar days after you first pay a contractor $600 or more in a calendar year or sign a contract for that amount, whichever comes first (EDD: contractor reporting).

The EDD says the report applies when all three statements are true: you must file a federal Form 1099-NEC or 1099-MISC for the services, you pay or contract for $600 or more, and the contractor is an individual, a sole proprietor or a single-member LLC treated as a sole proprietorship for federal tax. The EDD says corporations, general partnerships and other LLCs are not reported (EDD: contractor reporting). The federal 1099-NEC threshold for payments made in this page's tax year is $2,000, so check the first statement too (who gets a 1099).

• Report each contractor once per calendar year, for new or ongoing contracts. A verbal contract counts, and parts and materials count toward the total.
• The rule covers contractors who work for your California operations even if they live elsewhere. File online through e-Services for Business or by mail or fax; you need not register as an employer just to file.
• A late report costs $24 per failure without good cause, and $490 if the failure is intentional or the report is false.

The report exists to help track parents who owe child support; it is not an EDD finding that the worker is a contractor. A worker who fails the ABC test is an employee, and employees are reported through the New Employee Registry instead (EDD: contractor reporting; see California payroll setup).

Example

All examples use US dollars and round, illustrative numbers.

A marketing agency's full-time copywriter

A Los Angeles agency pays a copywriter $5,000 a month on a 1099, $60,000 over a year. The agency sets her hours and supplies her tools, and she writes the copy the agency sells. Part A is unlikely to be met because the agency controls the work, and Part B is not met because copywriting is its usual business. One failed part is enough, so she would be an employee for the EDD unless an exception applies. The marketing and writing exception applies only if the agency first meets its listed conditions, so it should not assume it does. The months already paid are the open question: back taxes, any penalty and interest.

A restaurant's freelance web designer

A San Diego restaurant pays a freelance designer $3,000 to build its website. She picks her own hours and software, has other clients, holds a business license and advertises her work, and a website is outside a restaurant's usual course of business. Parts A, B and C can all be met, but only if the restaurant can show each fact: the written scope and price, her invoice, her license and her other clients. If she is an individual or a single-member LLC taxed as a sole proprietorship, and the restaurant must file a 1099-NEC for the payment, it also files the DE 542 within 20 calendar days of agreeing to the $3,000 job or first paying her, whichever comes first.

A startup's three engineers on 1099s

A San Jose startup paid three software engineers, none licensed as an engineer, $90,000 each on 1099s for a year, $270,000 in all. The licensed-professional exception does not reach them, so the ABC test applies. Suppose they work as individuals, no other exception applies and they build the product the startup sells, so Part B fails. Going forward the startup registers with the EDD if it has no account, puts them on payroll and carries workers' compensation; the state payroll taxes and their current rates are in California payroll setup. The prior year is the harder question. If the startup never registered or filed, a 15% penalty on the contributions is mandatory and the EDD can reach back up to eight years. If it filed returns for other staff and left the engineers out, the 15% penalty applies only for negligence or intentional disregard, and the usual limit is three years. Interest runs either way. If an investor raised the issue, see contractors found misclassified in due diligence.

Different for you?

• The EDD sent a letter or audit notice, a worker says they are an employee, or you pay several people on 1099s who work like staff: gather each worker's contract, invoices, instructions about hours and methods, other clients and any EDD notice. For booking and reporting what was already paid, and catching up books that are behind, get bookkeeping help; whether a worker is an employee is settled under the test above, by the EDD, or by a lawyer in a dispute.
• This is your first California hire: see California payroll setup.
• You need the federal test, past federal filings or IRS relief: see contractors who may be employees.
• You are comparing what an employee costs against a contractor: see cost of an employee vs a contractor.
• Payroll deposits or returns are already late: see behind on payroll taxes.
• You are unsure who gets a 1099-NEC: see which contractors get a tax form.
• Investors flagged your contractors during diligence: see contractors found misclassified in due diligence.