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The ABC Test Determines Employee or Independent Contractor Status
On September 18, 2019, Governor Newsom Signed California Assembly Bill 5 (AB 5) into law which codified and expanded the California Supreme Court’s decision in the Dynamex case which established the “ABC” test for determining whether a worker is classified as an employee or independent contractor. The new law has substantially increased the cost of doing business in California for homeowner associations and businesses.
The ABC Test
What is the ABC test?
Under the ABC test, a worker is considered an employee and not an independent contractor, unless the hiring entity satisfies all three of the following conditions:
- 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 for the performance of the work and in fact;
- The worker performs work that is outside the usual course of the hiring entity’s business; and
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Below is a summary of the California Supreme Court’s explanation of how to apply the ABC test.
Part A: Is the worker free from the control and direction of the hiring entity in the performance of the work, both under the contract for the performance of the work and in fact?
In analyzing Prong A of the ABC test, the California Supreme Court in Dynamex explained:
- A worker who is subject, either as a matter of contractual right or in actual practice, to the type and degree of control a business typically exercises over employees would be considered an employee.
- Depending on the nature of the work and overall arrangement between the parties, a business need not control the precise manner or details of the work in order to be found to have maintained the necessary control that an employer ordinarily possesses over its employees.
PART B: Does the worker perform work that is outside the usual course of the hiring entity’s business
In analyzing Prong B of the ABC test, the California Supreme Court in Dynamex explained:
- Contracted workers who provide services in a role comparable to that of existing employees will likely be viewed as working in the usual course of the hiring entity’s business.
The California Supreme Court in Dynamex provided the following examples of Prong B being applied:
Prong B is satisfied (e., services are not part of the hiring entity’s usual course of business):
- When a retail store hires an outside plumber to repair a leak in a bathroom on its premises.
- When a retail store hires an outside electrician to install a new electrical line.
PART C: Is the worker customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity?
In analyzing Prong C of the ABC test, the California Supreme Court in Dynamex and subsequent appellate court decisions explained:
- The hiring entity must prove the independent business operation is actually in existence at the time the work is performed. The fact that the business operation could come into existence in the future is not sufficient.
- An individual who independently has made the decision to go into business generally takes the usual steps to establish and promote that independent business.
Examples of this include:
- Incorporation, licensure, advertisements,
- Routine offerings to provide the services of the independent business to the public or to a number of potential customers, and the like.
- Prong C is not necessarily satisfied:
- Where the hiring entity unilaterally assigns the worker the label “independent contractor.”
- Where the hiring entity requires the worker, as a condition of hiring, to enter into a contract that designates the worker an independent contractor.
If an individual’s work relies on a single employer. For example, Prong C was not satisfied where a taxi driver was required to hold a municipal permit that may only be used while that driver is employed by a specific taxi company.
Frequently Asked Questions About the ABC Test
Does the ABC Test Apply in All Situations?
No. There are situations where the ABC test will not apply:
- Sometimes the Legislature or the Industrial Welfare Commission has defined the employment relationship in a specific way. In such cases, the ABC test will not otherwise apply to establish employee status or employer liability. Rather, the specific language contained in the IWC wage orders, the Labor Code, or Unemployment Insurance Code will remain in effect.
- Additionally, where a court determines the ABC test cannot apply for a reason other than an express exception, the Borello test, described below, will apply. For example, if a court were to determine in a particular case that the ABC test is preempted by an applicable federal law, the Borello test would be used.
- Finally, the ABC test may not apply for certain occupations and contracting relationships. See Borello test below.
What is the Borello test?
The California Supreme Court established the Borello test in S.G. Borello & Sons, Inc. v. Dept. of Industrial Relations (1989) 48 Cal.3d 341. The test relies upon multiple factors to make that determination, including whether the potential employer has all necessary control over the manner and means of accomplishing the result desired, although such control need not be direct, actually exercised or detailed. This factor, which is not dispositive, must be considered along with other factors, which include:
- Whether the worker performing services holds themselves out as being engaged in an occupation or business distinct from that of the employer;
- Whether the work is a regular or integral part of the employer’s business;
- Whether the employer or the worker supplies the instrumentalities, tools, and the place for the worker doing the work;
- Whether the worker has invested in the business, such as in the equipment or materials required by their task;
- Whether the service provided requires a special skill;
- The kind of occupation, and whether the work is usually done under the direction of the employer or by a specialist without supervision;
- The worker’s opportunity for profit or loss depending on their managerial skill;
- The length of time for which the services are to be performed;
- The degree of permanence of the working relationship;
- The method of payment, whether by time or by the job;
- Whether the worker hires their own employees;
- Whether the employer has a right to fire at will or whether a termination gives rise to an action for breach of contract; and
- Whether or not the worker and the potential employer believe they are creating an employer-employee relationship (this may be relevant, but the legal determination of employment status is not based on whether the parties believe they have an employer-employee relationship).
Borello is referred to as a “multifactor” test because it requires consideration of all potentially relevant facts – no single factor controls the determination. Courts have emphasized different factors in the multifactor test depending on the circumstances. For example, where the employer does not control the work details, an employer-employee relationship may be found if (1) the employer retains control over the operation as a whole, (2) the worker’s duties are an integral part of the operation, and (3) the nature of the work makes detailed control unnecessary. (Yellow Cab Cooperative, Inc. v. Workers’ Compensation Appeals Board (1991) 226 Cal.App.3d 1288.)
As the Supreme Court has explained, Borello “emphasizes statutory purpose as the touchstone for deciding whether a particular category of workers should be considered employees rather than independent contractors for purposes of social welfare legislation.” (Dynamex, 4 Cal.5th at 935.) The emphasis on statutory purpose “sets apart the Borello test for distinguishing employees from independent contractors from the [common law] standard . . . in which the control of details factor is given considerable weight.” (Id.)
How does the ABC test compare to the Borello test?
Both the Borello test and the ABC test assume that the worker is an employee, and the hiring entity must prove that the worker is an independent contractor.
However, the ABC test is designed to make it easier for both businesses and workers to determine in advance whether a worker is an independent contractor or an employee. In other words, it is aimed at being more predictable than the multifactor approach used under Borello.
Unlike the ABC test — in which the inability of the hiring entity to demonstrate any part of the three-part test means that the worker is not an independent contractor — under the Borello test, no single factor determines whether a worker is an employee or an independent contractor. As described above courts consider all potentially relevant factors on a case-by-case basis in light of the nature of the work, the overall arrangement between the parties and the purpose of the law.
ABC Test Exceptions
While the ABC test is the applicable test for most workers, for some jobs and industries Labor Code section 2775 et seq. apply the Borello multifactor test, described above. For some occupations, the Borello test applies without further requirements. However, for other occupations and industries, the Borello test applies instead of the ABC test only after the hiring entity satisfies other requirements first. Finally, for certain real estate licensees and repossession agencies, standards under the California Business and Professions Code will continue to apply.
Occupations where the Borello test applies instead of the ABC test under Labor Code sections 2775 et seq.:
- Certain occupations in connection with creating, marketing, promoting, or distributing sound recordings or musical compositions
- Certain licensed insurance agents, brokers, and persons who provide underwriting inspections, premium audits, risk management, or loss control work for the insurance and financial service industries
- Certain licensed physicians, surgeons, dentists, podiatrists, psychologists, or veterinarians
- Certain licensed attorneys, architects, landscape architects, engineers, private investigators and accountants
- Certain registered securities broker-dealers or investment advisers or their agents and representatives
- Certain direct salespersons
- Certain licensed commercial fishermen (only through December 31, 2022 unless extended by the Legislature)
- Certain newspaper distributors or carriers (only through December 31, 2020 unless extended by the Legislature)
- Certain persons engaged by an international exchange visitor program
- Certain competition judges
- Certain home inspectors, as defined in Section 7195 of the Business and Professions Code, and subject to the provisions of Chapter 9.3 (commencing with Section 7195) of Division 3 of that code.
Occupations or contracting relationships where Labor Code sections 2775 et seq. requires that additional requirements must first be met in order to use the Borello test instead of the ABC test:
- Certain professional services contracts for marketing; human resources administration; travel agents; graphic design; grant writers; fine artists; enrolled agents licensed to practice before the IRS; payment processing agents; still photographers / photojournalists; videographers; photo editors to a digital content aggregator; freelance writers, translators, editors, copy editors, illustrators, or newspaper cartoonists; content contributors, advisors, producers, narrators, or cartographers for a journal, book, periodical, evaluation, other publication or educational, academic, or instructional work in any format or media; licensed barbers, cosmetologists, electrologists, estheticians, or manicurists (manicurists only through December 31, 2021); specialized performing arts Master Class Instructors, appraisers, registered professional foresters, and data aggregators, as defined. Borello applies to determine whether the individual is an employee of the hiring entity if initial requirements are met.
- Relationships between two individuals working on a single engagement event, defined as a stand-alone non-recurring event in a single location, or a series of events in the same location no more than once a week. Borello applies if initial requirements are met.
- Certain individuals performing work under a subcontract in the construction industry, including construction trucking (with certain specific conditions applicable to construction trucking only through December 31, 2021). Borello and Labor Code section 2750.5 apply to determine whether the individual is an employee of the contractor if initial requirements are met.
- Certain service providers who are referred to customers through referral agencies to provide services including, but not limited to, graphic design, web design, photography, tutoring, consulting, youth sports coaching, caddying, wedding or event planning, services provided by wedding and event vendors, minor home repair, moving, errands, furniture assembly, animal services, dog walking, dog grooming, picture hanging, pool cleaning, yard cleanup, and interpreting. Borello applies to determine whether the service provider is an employee of the referral agency if initial requirements are met.
- The following services are excluded: services provided in an industry designated as a high hazard industry, janitorial, delivery, courier, transportation, trucking, agricultural labor, retail, logging, in-home care, or construction services other than minor home repair.
- Certain individuals performing services pursuant to a third party’s contract with a motor club to provide motor club services. Borello applies to determine whether the individual is an employee of the motor club if initial requirements are met.
- Certain bona fide business-to-business contracting relationships. Borello applies to determine whether the business providing services is an employee of the business contracting for the services if initial requirements are met.
For two specific industries, special rules under Labor Code section 2778(b) require examination under the Business and Professions Code:
- Certain real estate licensees, for whom the test of employee or independent contractor status is governed by section 10032(b) of the Business and Professions Code. (If that section is not applicable, then Borello is the applicable test for purposes of the Labor Code, except ABC will be the applicable test for purposes of workers’ compensation as of July 1, 2020.)
- Certain repossession agencies, for which the determination of employee or independent contractor status is governed by Section 7500.2 of the Business and Professions Code.
The exemptions from the ABC test for certain industries, occupations, or contracting relationships may involve some complicated rules and criteria which are not set forth above. Employers and workers should seek independent advice and counsel if they have questions about the applicability of any exemption to their particular case.
If a hiring entity has a worker sign an agreement stating that the worker is an independent contractor, does not make payroll deductions or withholdings for taxes or Social Security for the worker, and at the end of the year provides the worker with an IRS Form 1099 rather than a W-2, does this mean the worker is an independent contractor?
No. Being labeled an independent contractor, being required to sign an agreement stating that one is an independent contractor, or being paid as an independent contractor (that is, without payroll deductions and with income reported by an IRS Form 1099 rather than a W-2), is not what determines employment status. The ABC test — or where appropriate, the Borello test or other standard under Labor Code section 2775 et seq. (see Questions 2, 5, and 7 above) — are used to determine employment status. An employer cannot change a person’s status from that of an employee to one of an independent contractor by requiring a written agreement to that effect or by giving them an IRS Form 1099 instead of a W-2.
Are there penalties for misclassifying workers as independent contractors?
Yes. In addition to penalties that may be assessed for wage violations associated with a worker being misclassified as an independent contractor, there are civil penalties for willful misclassification. Under Labor Code section 226.8, which prohibits the willful misclassification of individuals as independent contractors, there are civil penalties of between $5,000 and $25,000 per violation. Willful misclassification is defined as voluntarily and knowingly misclassifying an employee as an independent contractor.
What difference does it make if a worker is an employee rather than an independent contractor?
California’s wage and hour laws (e.g., minimum wage, overtime, meal periods and rest breaks, etc.), workplace safety laws, and retaliation laws protect employees, but not independent contractors. Additionally, employees can go to state agencies such as the Labor Commissioner’s Office to seek enforcement of these laws, whereas independent contractors must resolve their disputes or enforce their rights under their contracts through other means.
What risks do employers face under the Unemployment Insurance Code for not properly classifying employees?
If EDD finds that workers are misclassified as independent contractor(s) when they should be classified as employee(s), employers face significant risks related to failing to comply with their obligations under the Unemployment Insurance Code. These risks include under-paying their taxes and having to pay their employees’ share of payroll taxes, both of which may result in incurring penalties and interest.
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