By Ryan Danz, Founding Attorney, Employer Guidance Group PC
Disclaimer: This article is general information about California law — not legal advice, and not a substitute for having counsel review your specific policies. Reading it does not create an attorney-client relationship. Employment law changes frequently; consult a licensed California employment attorney about your situation before acting.
The 1099 you send every January proves nothing. Neither does the contractor agreement your bookkeeper signed. In California, a person you pay for work starts out as an employee, and your business carries the burden of proving otherwise.
Most owners ask whether someone feels like a contractor. The law asks whether you can prove three specific facts. Miss one, and that person is generally your employee for wage, unemployment insurance and payroll tax purposes.
How to tell if a worker is an employee: the ABC test
Labor Code § 2775 sets the default for the Labor Code, the Unemployment Insurance Code and the IWC wage orders. The California Supreme Court adopted the test in Dynamex Operations West, Inc. v. Superior Court (No. S222732, 2018), and AB 5 wrote it into statute effective January 1, 2020. The hiring entity must establish all three parts.
| Part | What you must prove | Where it tends to fall apart |
|---|---|---|
| A | The worker is free from your control and direction, on paper and in practice | You set the schedule, require your procedures, or supervise the work |
| B | The work is outside the usual course of your business | The worker does the thing your company sells |
| C | The worker is customarily engaged in an independently established business of the same nature | One client, no customers of their own, no business to point to |
Part B is the one no contract can fix. A dental office that hires an outside plumber to repair a leak is in a strong position on B. A plumbing company that "contracts" with plumbers to run its service calls is not.
Part C trips up owners who say their worker is free to take other clients. In Garcia v. Border Transportation Group, LLC (Cal. Ct. App., 4th Dist., Div. 1, No. D072521, 2018), the court asked whether the worker actually had an independent business, not whether he could have one.
Can I pay someone as a 1099 contractor in California?
Only if the worker passes the applicable test. The Labor Commissioner's FAQ says a 1099 does not determine status, that signing a contractor agreement does not settle it, and that a business cannot decide status by assigning a label.
A federal change would not rescue you either. The U.S. Department of Labor proposed a new contractor rule in February 2026, but § 2775 governs the California codes on its own terms.
AB 5 exemptions: what they actually give you
An exemption is not a pass. It swaps the ABC test for the older multifactor Borello test, and only after you prove every condition of the exemption.
| Route | Statute | What you must prove first | Test that then applies |
|---|---|---|---|
| No exemption | § 2775 | Nothing | ABC |
| Business-to-business | § 2776 | All 12 criteria, including a written contract stating pay, rate and due date, a separate business location, public advertising, and the ability to negotiate rates | Borello |
| Professional services | § 2778 | Six factors, plus a listed occupation such as marketing, HR administrator, graphic design, grant writer or enrolled agent | Borello |
Three cautions. Each listed occupation has its own definition, and some carry extra conditions, so a job title alone does not qualify. Hiring through an LLC does not automatically solve the problem, because under § 2776(b) an individual worker who is not a sole proprietor or business entity is still classified under § 2775. And other statutes cover other relationships, so check for one before assuming no exemption exists. Whether §§ 2776 or 2778 have seen a 2026 amendment is an open question worth confirming before you rely on the current text.
Borello is not a free pass either. The Labor Commissioner lists the main factor as control over the manner and means of the work, then weighs whether the worker runs a distinct business, whether the work is integral to yours, who supplies tools and the location, investment, skill, opportunity for profit or loss, permanence, how the worker is paid, whether the worker has employees, and whether you can fire at will. No single factor controls.
What misclassification costs
| Exposure | Amount or scope | Source |
|---|---|---|
| Unpaid wages | Minimum wage and overtime, plus restitution | LWDA FAQ |
| Payroll taxes | Unemployment insurance taxes and the employee's share of payroll taxes, plus penalties and interest | Labor Commissioner FAQ |
| EDD penalty | 15% of the deficiency for negligent or intentional disregard | Labor Commissioner FAQ |
| Workers' compensation | Coverage the worker should have had | Labor Commissioner FAQ |
| Willful misclassification | $5,000 to $15,000 per violation | Lab. Code § 226.8(b) |
| Pattern or practice | $10,000 to $25,000 per violation | § 226.8(c) |
| Public notice | Officer-signed notice posted on your website for one year, if ordered | § 226.8(e)-(f) |
"Willful" means voluntarily and knowingly misclassifying to avoid employee status. That is why an audit finding you ignore is worse than one you never ran.
The ripple effects stack on top. Reclassified workers may also raise expense reimbursement, wage statement and PAGA claims.
The steps below are general information, not legal advice. Have counsel tailor them to your workforce and practices before you act.
Your contractor audit checklist
- List everyone you paid on a 1099 in the last three years.
- Test Part B first. If the work is what your business sells, look for an exemption or plan to convert.
- Test Parts A and C against what happens day to day, not what the contract says.
- For any exemption, write down the proof for every criterion, not just most of them.
- Collect the evidence now: business license, website or advertising, other clients, and the worker's own tools.
- Rewrite contracts to state services, pay, rate and due date, and remove exclusivity terms.
- Get legal advice on back wages and taxes before moving anyone to payroll, because the conversion itself creates a record.
- Never retaliate. A worker fired for complaining about misclassification can file with the Labor Commissioner or sue.
If your company is based elsewhere and has California workers, start with our statute-by-statute guide for out-of-state employers.
Get your contractors reviewed before someone else does
Employer Guidance Group defends California employers in wage and hour and PAGA matters and runs compliance audits. Contact us to review your contractor relationships.
Disclaimer
This article is general information about California law. It is not legal advice, and reading it does not create an attorney-client relationship. Employer Guidance Group PC is not your attorney unless and until you have signed a written engagement agreement with the firm.
California employment law changes constantly. The information here may be incomplete, out of date, unverified, or incorrect, and it does not account for your specific facts — and outcomes turn on facts. Do not act, or refrain from acting, on the basis of this article. Consult a licensed attorney about your own situation before making any employment decision.
This communication may constitute attorney advertising. Prior results do not guarantee a similar outcome.