California has some of the strictest worker classification laws in the country, and the passage of Assembly Bill 5 (AB 5) has only reinforced the state’s commitment to worker protections. For small and medium-sized businesses, ensuring compliance with these laws is crucial to avoid costly misclassification lawsuits, penalties, and regulatory scrutiny.
The distinction between an independent contractor and an employee is more than just a label—it determines whether a worker is entitled to labor protections, such as minimum wage, overtime pay, and benefits. Misclassification can result in severe consequences, including back wages, tax liabilities, and potential civil lawsuits. Let’s break down the laws regarding employment classification in California.
Understanding AB 5 and the ABC Test
AB 5, which took effect on January 1, 2020, codified the California Supreme Court’s landmark decision in Dynamex Operations West, Inc. v. Superior Court (2018). This decision significantly narrowed the circumstances under which a worker could be classified as an independent contractor. AB 5 introduced the ABC test, making it the default standard for determining worker classification.
The law was enacted to address concerns about companies misclassifying workers as independent contractors to avoid providing benefits, unemployment insurance, and workplace protections. While independent contractor arrangements can provide flexibility, they can also leave workers vulnerable to exploitation if improperly classified.
AB 5 has had a significant impact on various industries, including ride-hailing services, trucking, entertainment, and freelance work. While some businesses have successfully adapted, others have faced legal battles and significant financial penalties for misclassification.
The ABC Test: The Core of Worker Classification
AB 5 introduced the ABC test, which presumes that a worker is an employee unless the hiring entity can prove all three of the following conditions:
(A) The worker 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. This means the worker must be able to perform their work without significant oversight from the employer. If the business controls how, when, or where the worker performs their tasks, the worker is likely an employee.
(B) The worker performs work that is outside the usual course of the hiring entity’s business. This is the most challenging part of the test for many businesses. If the worker provides services that are integral to the company’s main business operations, they are likely an employee. For example, a bakery hiring a freelance cake decorator to design specialty cakes may fail this test because decorating cakes is part of the bakery’s core business.
(C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity. The worker must be independently providing similar services to other businesses, not just working for one company. For instance, a freelance graphic designer with multiple clients and their own website or business license is more likely to qualify as an independent contractor.
Failing to satisfy any one of these prongs means the worker must be classified as an employee.
Overview of AB 2257 and Its Modifications to AB 5
The strict ABC standard led to unintended consequences, particularly for freelancers and gig workers. The passage of AB 2257 in September 2020 addressed these concerns by modifying the law to include additional exemptions and clarifications to AB 5.
While AB 5 still governs worker classification, AB 2257 created new exemptions, allowing more workers to be classified as independent contractors under a less restrictive test.
The exemptions under AB 2257 allow certain professionals and industries to bypass the ABC Test and instead be classified under the Borello Test—a more flexible standard that focuses on multiple factors, including the level of control a hiring entity has over a worker and whether the work is project-based. These exemptions include:
1. Freelance Writers and Journalists
AB 5 originally placed strict caps on freelance writers, limiting them to 35 submissions per client per year before they would have to be classified as employees. This caused major disruptions in the journalism and publishing industries.
How AB 2257 changed the law:
- The 35-submission cap was eliminated, allowing writers and journalists to freely contract without an arbitrary restriction.
- Freelance editors, copy editors, and content creators are also exempt, provided they have control over their work and do not replace regular employees.
- Independent photojournalists and videographers are exempt as long as they don’t shoot video content for scripted content like television shows or advertisements.
Industries Impacted:
- News agencies, magazines, and online publications.
- Freelance journalism, blogging, and editorial work.
- Content marketing and advertising industries.
2. Musicians and Performing Artists
AB 5 caused serious issues for musicians, bands, and performing artists, making it difficult for venues to book independent talent without the burden of classifying them as employees.
How AB 2257 changed the law:
- Musicians, composers, and songwriters can now work as independent contractors.
- Live performers, bands, and solo artists who perform original music at venues or private events are exempt.
- Recording artists and session musicians are covered under exemptions, allowing them to work with studios without being classified as employees.
- Event organizers and booking agents can hire musicians on a contract basis without violating AB 5.
Industries Impacted:
- Live entertainment and music venues.
- The recording industry and music production.
- Independent performers and artists.
3. Certain Business-to-Business Relationships
One of the biggest concerns with AB 5 was that it harmed small business owners and independent professionals who worked with other businesses on a contractual basis.
How AB 2257 changed the law:
- Expands the business-to-business exemption for independent contractors operating as sole proprietors or LLCs.
- Allows freelancers and independent businesses to work with companies without being classified as employees, as long as they control their work and pricing, they provide services directly to the hiring business, not its clients, and they maintain separate business locations and handle their own expenses.
Industries Impacted:
- Independent consultants and marketing professionals.
- Graphic designers, IT professionals, and web developers.
- Business services like bookkeeping, administrative support, and coaching.
4. Referral Agencies and Professional Services
AB 2257 provides clearer exemptions for referral agencies that connect clients with independent professionals for specialized services.
How AB 2257 changed the law:
- Referral agencies, such as those that connect customers with independent cleaners, dog walkers, or event planners, are exempt from AB 5 restrictions.
- However, the professionals they refer must meet specific independence requirements, including:
- Setting their own rates.
- Choosing their own clients.
- Providing their own tools and supplies.
Industries Impacted:
- Home services (cleaning, repair, moving).
- Personal services (tutors, dog walkers, fitness trainers).
- Consulting and professional networks.
How Exemptions Work and Additional Requirements for Businesses
While AB 2257 expanded exemptions, it did not eliminate all restrictions on independent contracting. Businesses and workers must still comply with California law when structuring their relationships.
1. Independent Contractors Must Meet the Borello Test
Even with an exemption from the ABC Test, workers must still satisfy the Borello factors, which examine:
- Who controls the manner and means of work.
- Whether the worker supplies their own tools and materials.
- Whether the worker has an independent business or offers services to multiple clients.
2. Contracts and Documentation Are Key
Businesses hiring independent contractors must have clear agreements in place outlining:
- The scope of work and payment terms.
- The independent nature of the relationship.
- Acknowledgment that the worker is responsible for their own expenses and taxes.
3. Industry-Specific Compliance May Still Apply
Even for exempt professions, businesses should check if other state or federal labor laws apply. Some industries, like transportation and healthcare, still face strict classification rules even after AB 2257.
How Small and Medium Employers Can Stay Compliant with California’s Independent Contractor Laws
Misclassifying employees as independent contractors can lead to serious legal and financial repercussions, including:
- Civil penalties and back wages: Businesses may be required to pay unpaid wages, benefits, and penalties for violating wage and hour laws.
- State audits and fines: The California Labor Commissioner’s Office and Employment Development Department (EDD) conduct audits that can lead to hefty penalties.
- Potential lawsuits: Workers can sue for misclassification, seeking damages for unpaid wages, denied benefits, and emotional distress.
- Tax liabilities: The IRS and state tax agencies may impose penalties for failure to withhold payroll taxes.
As a result, California’s strict independent contractor laws can present significant challenges for small and medium-sized businesses. Ensuring compliance with AB 5 and AB 2257 is critical to avoiding lawsuits, audits, and penalties. Below is a comprehensive guide on how companies can evaluate their workforce, properly classify workers, explore alternative staffing solutions, and defend against misclassification claims.
Evaluating Your Current Workforce
Before making any hiring or classification decisions, businesses should conduct a thorough assessment of their existing workforce to ensure compliance with California law.
Conducting an Internal Audit of Worker Classifications
A worker classification audit helps identify potential misclassification risks before legal issues arise. Employers should:
- Identify all independent contractors currently working for the company.
- Evaluate job duties to determine if workers meet the ABC test requirements.
- Review past hiring practices to ensure consistency in classification decisions.
- Consult with HR professionals or legal counsel if misclassification risks are identified.
If a worker fails any part of the ABC test, they may need to be reclassified as an employee.
Reviewing Contracts and Job Descriptions
Businesses should carefully review all contracts and job descriptions to ensure they align with independent contractor classification. This includes:
- Ensuring contracts clearly state that the worker is an independent contractor.
- Defining job duties to reflect independence—workers should not perform tasks central to the company’s core business.
- Avoiding language that suggests employer control over work schedules, methods, or supervision.
A properly structured contract alone does not determine independent contractor status—the actual work relationship must also meet legal requirements.
Assessing the Level of Control Over Independent Contractors
One of the most critical factors in classification is how much control the business exercises over the worker. To maintain independent contractor status:
- The worker should set their own hours and work schedule.
- They should use their own tools and equipment.
- They should work for multiple clients, not just one company.
- Payment should be structured per project, not on an hourly or salary basis.
If a business exerts too much control, the worker is likely an employee, even if they are labeled an independent contractor.
Best Practices for Properly Classifying Workers
If a worker qualifies as an independent contractor, businesses should take proactive steps to maintain compliance and minimize misclassification risks. To align with AB 5, businesses should:
- Clearly define independent contractor roles to ensure they fall outside the company’s usual business operations.
- Ensure contractors operate their own businesses and work with multiple clients.
- Limit oversight and control over how contractors complete their work.
- Avoid long-term contractor relationships that resemble employment.
While a written contract alone does not determine classification, it is an essential part of protecting a business. A strong independent contractor agreement should specify that the worker is an independent contractor, not an employee. It should also define project-based work rather than ongoing employment, ensure the contractor has the right to take on other clients and avoid clauses that impose excessive control over the worker’s tasks or schedule.
In addition, businesses should maintain detailed records to support independent contractor classification, including:
- Invoices from contractors showing project-based payment structures.
- Payment records proving that contractors were not paid hourly.
- Email communications demonstrating the worker’s independence.
- Proof of the worker’s separate business operations, such as websites or marketing materials.
Proper documentation is essential in defending against EDD audits or legal claims.
Defending Against Misclassification Claims
Suppose your business faces an EDD, IRS, or Labor Commissioner audit. In that case, it is crucial to seek legal guidance from an experienced employment law firm. A California employment law attorney from Chauvel & Glatt, LLP, can assist you during this process by:
- Reviewing worker classifications and ensuring compliance.
- Assisting in responding to audits and investigations.
- Developing a legal defense strategy against misclassification claims.
- Helping your business implement best practices to avoid future issues.
By taking proactive steps and seeking legal guidance, businesses can mitigate misclassification risks while maintaining workforce flexibility.
Take a Proactive Approach to California Employment Classification
Worker classification under California’s strict independent contractor laws is a complex and evolving issue. Small and medium-sized businesses must stay informed about AB 5, AB 2257, and the ABC test to avoid legal pitfalls.
By conducting proper workforce evaluations, maintaining clear contracts, and consulting legal professionals when necessary, employers can mitigate risks and ensure compliance. Given the high stakes of misclassification lawsuits, taking proactive steps now can prevent significant financial and legal consequences down the road. At Chauvel & Glatt, LLP, we pride ourselves on supporting businesses like yours with the complexities of independent contractor classification laws. Whether you are currently facing an audit or you want to implement best practices for employee classification, our employment law attorneys are available for a consultation. Schedule your appointment today to discuss your needs and discover more about how Chauvel & Glatt may be able to support your business.
