If you work with independent contractors in California, the classification rules are worth keeping up with, because they have shifted repeatedly and the default has moved toward employee status. This guide covers the difference between employees and contractors, the common-law test, the Dynamex decision, and what the current legislation means for EDD audits.
Employees vs Independent Contractors
Employees generally work under the direction and control of an employer. The employer determines how, when and where work is performed, provides the necessary tools or equipment, and is responsible for payroll taxes, unemployment insurance, workers’ compensation coverage and employee benefits where applicable.
Independent contractors typically operate their own businesses, control their own working methods, use their own equipment, and often provide services to several clients.
Classifying workers correctly matters because in California employee wages are subject to state payroll taxes while payments to independent contractors are not. In general a worker is treated as an employee unless the criteria below are met.
The ABC Test
The ABC Test is the starting point. A worker is considered an employee unless the hiring entity can establish all three of the following:
- The individual is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract and in fact.
- The individual performs work that is outside the usual course of the hiring entity’s business.
- The individual is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.
If any one of the three is not met, the individual is an employee. Some occupations fall outside the ABC Test entirely, and our note on the exceptions to AB5 sets out which.
What is a Common Law Employee in California?
Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. That holds even where you give the worker considerable freedom of action: what matters is that you have the right to control the details of how the services are performed.
Where an employer-employee relationship exists, the label attached to it makes no difference. The substance of the relationship governs the worker’s status, and it does not matter whether the individual works full time or part time.
Determining status under the common-law rules means examining the relationship between the worker and the business, and weighing all the evidence of the degree of control and the degree of independence. That evidence falls into three categories: behavioral control, financial control, and the type of relationship between the parties.
Behavioral control refers to facts showing whether there is a right to direct or control how the worker does the work. A worker is an employee where the business has that right. The business does not have to actually exercise it, provided the right exists. The behavioral control factors fall into the following categories.
Type of Instructions Given
An employee is generally subject to the business’s instructions about when, where and how to work. Examples of such instructions include:
- When and where to do the work.
- What tools or equipment to use.
- What workers to hire, or to assist with the work.
- Where to purchase supplies and services.
- What work must be performed by a specified individual.
- What order or sequence to follow when performing the work.
Degree of Instruction
The more detailed the instructions, the more control the business exercises. Detailed instructions indicate an employee. Less detailed instructions reflect less control and point toward an independent contractor.
Evaluation Systems
If an evaluation system measures the details of how the work is performed, that points toward an employee. If it measures only the end result, it can point either way.
Training
Where the business trains the worker in how to do the job, that indicates it wants the job done in a particular way, which is strong evidence of employee status. Periodic or ongoing training about procedures and methods is stronger evidence still. Independent contractors ordinarily use their own methods.
The Dynamex Case
The California Supreme Court’s decision in Dynamex Operations West, Inc. v. Superior Court was a turning point in the state’s approach to worker classification. Issued in 2018, it changed how businesses determine whether workers should be treated as employees or independent contractors for the purposes of California wage orders.
Background of the Case
Before Dynamex, California relied principally on the Borello test, a multifactor analysis examining several aspects of the working relationship, with the employer’s right to control the worker carrying significant weight. That approach offered flexibility but often produced inconsistent outcomes and uncertainty for businesses and workers alike.
The case involved delivery drivers who argued they had been improperly classified as independent contractors even though the company exercised substantial control over their work. They claimed that as a result they had been denied workplace protections including minimum wage, overtime pay, and meal and rest breaks.
Introduction of the ABC Test
The court replaced the Borello analysis for wage order claims with the ABC Test, establishing a presumption that workers are employees unless the hiring entity can prove otherwise.
Why the Decision Was Significant
Dynamex strengthened worker protections by making employee status the default in many situations, and prompted businesses across California to reexamine their contractor relationships and compliance practices.
It is worth noting that the decision initially concerned claims arising under California wage orders. It did not directly determine how classification applied to unemployment insurance, payroll taxes, or every provision of the Labor Code. Those questions were addressed later by legislation, principally Assembly Bill 5, which expanded and codified the ABC Test across much of California employment law.
AB5 and Employment Classifications Today
Following Dynamex, California enacted Assembly Bill 5 (AB5), which largely codified the ABC Test into state law.
What AB5 Accomplished
AB5 established the ABC Test as the default method for determining whether workers qualify as independent contractors under many California labor laws. It expanded worker protections and placed greater compliance responsibilities on employers.
Industry Exemptions
Recognizing that certain professions operate differently, lawmakers created exemptions for various occupations. Depending on the industry, exempt workers may continue to be assessed under the common-law standard rather than the ABC Test.
Those exemptions have evolved through later legislation, including AB 2257. Separately, Proposition 22 was approved by voters in November 2020 and exempts qualifying app-based drivers from the ABC Test; the California Supreme Court unanimously upheld it in Castellanos v. State of California in July 2024. Because the picture keeps changing, periodic review matters for any business relying on contractor relationships.
The Impact to Audit Exposure with the EDD
Any entity conducting business in California must report information on worker classification to the Employment Development Department. Information about an independent contractor must be reported within 20 days of entering into a contract valued over $600, or of making payments totaling $600, whichever comes first, and the reporting is done annually.
The EDD can audit to determine whether misclassification has occurred. Where a worker was treated as an independent contractor but should have been an employee, the EDD will assess payroll back-taxes for each year those taxes went unpaid. The legislation has also broadened the definition of an employee and the potential liability attaching to misclassification, which is why classification is worth checking before an auditor does it for you.
Classification is the most common trigger for an audit, as our note on working with contractors and audit risk explains, and what accounting firms should know covers the same ground from an adviser’s point of view.
Checking Where Your Arrangements Stand
Whether a role sits inside or outside the ABC Test usually turns on the facts of the working relationship rather than the job title or the wording of the contract, which is why a review is more useful than a template.
If you have questions about worker classification, contractor agreements, or how the current rules apply to your business, our payroll tax audit team works with California employers on classification and audit defense.
