Does California’s AB 5 Turn Your Contractors into Employees?

Contractors into Employees? AB 5 and What it’s About


The new California AB 5 law is somewhat troubling to both (a) employers, and (b) independent contractors, for the following reasons:

· Employers who hire independent contractors save on Social Security taxes, Medicare taxes, employment taxes, unemployment taxes, and paid vacation and other time off, and can avoid a host of workplace rules.

· Independent contractors enjoy workplace freedom, can deduct their business expenses, can set their own hours, and can generally put away as much as they desire into their solo 401(k) accounts.

Essentially, AB 5 by law, makes a lot of  independent contractors W-2 employees. Employers lose their advantages. Independent contractors lose their advantages.

This AB 5 independent-contractor-to-employee displacement does not just only affect businesses located in California.

You have to realize that large companies have 45 independent contractor sales reps, that may have three that were in California. This means that all sales reps would be treated the same, the company converted all the traveling sales reps to employees, who now suffer as does the individual in Dynamex Causing Incorrect W-2 Classifications for Independent Contractors.

Now here is where the domino effect can come into play. Other states may start to enact AB 5 or their versions of AB 5.

Currently, both New York and New Jersey are considering adopting an AB 5 law of some sort.

Have you been affected by this new law? Are your independent contractors now employees because of California’s new law? Read our article, and get the full scoop as it exists today.

Does This Apply to Me? 

If your business has workers based in California who perform services in California, they are subject to AB 5, and you need to know how AB 5 impacts both your workers and your business.

What Federal Law Says

Federal law looks to common-law principles for worker classification, which over the years have proven difficult to apply. But there’s the Section 530 rule that protects most businesses, as we explain in Avoid Employment Taxes and Penalties: Sail into Section 530’s Safe Harbor.

The IRS, in its efforts to make 1099 independent contractors W-2 employees, relied for years on a 20-factor test. This test proved cumbersome, and today the IRS has broken the 20 factors in three broad factors as described below:

1. Behavioral control. You look more like an employee if the company you work for has a lot of control over the day-to-day details of your work, such as through specific instructions in your contract or through a supervisor. On the other hand, you look more like an independent contractor if you primarily decide how to perform your work.

2. Financial control. You look more like an independent contractor if you have invested significantly in your business, if you have unreimbursed expenses, and if you run the possibility of incurring a loss.

3. Type of relationship. You look more like an employee if you work exclusively for the company; plan to work there indefinitely; and get benefits such as retirement plans, sick days, and medical benefits.

Take a look at the following articles to understand more about the federal common-law rules:

  • Slash Employment Taxes: Take Three Steps Before Hiring Workers
  • What Is a 1099 Independent Contractor?
  • Do You Make This Big Mistake with Your Independent Contractors?

What California Law Used to Say

From 1989 until the enactment of AB 5 which became generally effective in 2020, the Borello test determined whether a worker was an employee or an independent contractor for California purposes.

The Borello test weighs 13 factors to determine whether an employer has the right to control the services performed by a worker:

  1. Whether the worker performing services appears to be engaged in an occupation or business distinct from that of the employer
  2. Whether the work is a regular or integral part of the employer’s business
  3. Whether the employer or the worker supplies the instrumentalities, the tools, and the place for the worker to do the work
  4. Whether the worker has invested in the business, such as in the equipment or materials required by his or her task
  5. Whether the service provided requires a special skill
  6. The kind of occupation, and whether the work is usually done under the direction of the employer or by a specialist without supervision
  7. The worker’s opportunity for profit or loss depending on his or her managerial skill
  8. The length of time for which the services are to be performed
  9. The degree of permanence of the working relationship
  10. The method of payment, whether by time or by the job
  11. Whether the worker hires his or her own employees
  12. Whether the employer has a right to fire at will or if a termination gives rise to an action for breach of contract
  13. Whether the worker and the employer believe they are creating an employer-employee relationship (a relevant consideration despite no basis as a legal determination)

What California Law Now Says

AB 5 codified a California Supreme Court case called Dynamex and made its ABC test generally applicable statewide unless your profession got a specific exemption.

The AB 5 law became effective January 1, 2020, with different time frames applying in select circumstances, such as the Workers’ Compensation Insurance rule that becomes effective on July 1, 2020.

Under the ABC test, the law presumes your workers are employees for California Labor Code and Unemployment Insurance Code purposes unless your business meets a three-factor test.

Your business must meet all three prongs of the ABC test to treat your worker as an independent contractor:

A. Your worker is free from your control and direction in connection with the performance of work, both under the contract for the performance of the work and in actual fact.

B. Your worker performs work that is outside the usual course of your business.

C. Your worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for you.

The A prong is similar to the control factors in the Borello test.

The B prong may be difficult for many businesses to meet. In Curry, the California Appeals Court gave an example of the B prong:

If a bakery hires cake decorators to work on a regular basis, then those cake decorators are likely working within the bakery’s “usual business operation,” and thus would be employees. Whereas an electrician hired to work at a bakery would likely be viewed as not working within the bakery’s usual course of business and therefore would not be viewed as an employee.

The C prong apparently requires that the worker already be in business for himself or herself, and work in a customarily independent profession. In Curry, the court explained it as follows:

This factor can be proven with evidence that the worker has “take[n] the usual steps to establish and promote his or her independent business—for example, through 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.”

AB 5 Exceptions

The following professions are exempt from the ABC test and continue to use the Borello test:

  • Certain licensed insurance agents and brokers
  • Certain licensed physicians, surgeons, dentists, podiatrists, psychologists, or veterinarians
  • Certain licensed attorneys, architects, engineers, private investigators, and accountants
  • Certain registered securities broker-dealers or investment advisors or their agents and representatives
  • Certain direct salespersons
  • Certain licensed commercial fishermen (only through December 31, 2022)
  • Certain newspaper distributors or carriers (only through December 31, 2020)

The following professions are exempt from the ABC test and can continue to use the Borello test provided the business meets other additional requirements:

  • 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; freelance writers, editors, or newspaper cartoonists; and licensed barbers, cosmetologists, electrologists, estheticians, or manicurists (manicurists only through December 31, 2021).
  • 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).
  • Certain service providers who are referred to customers through referral agencies to provide graphic design, photography, tutoring, event planning, minor home repair, moving, home cleaning, errands, furniture assembly, animal services, dog walking, dog grooming, web design, picture hanging, pool cleaning, or yard cleanup.
  • Certain individuals performing services pursuant to a third party’s contract with a motor club to provide motor club services.
  • Certain bona fide business-to-business contracting relationships.


AB 5 is controversial—there are multiple lawsuits challenging the law. The California Trucking Association; the American Society of Journalists and Authors, Inc.; and Uber and Postmates drivers all sued California in federal district court, and these cases are currently pending.

In addition, Uber, Lyft, and DoorDash filed paperwork to put forward a 2020 ballot initiative to exempt their workers from the ABC test.

Even though lawsuits are pending, AB 5 is the general law of the land for making the employee-or-independent contractor determination under California law.

Our General Thoughts

We will start off with this statement: this is a mess. Imagine treating your California worker as a W-2 employee for California purposes and then as an independent contractor for federal purposes. You could likely do this, but there would be complications.

If you don’t have California workers but you have independent contractors in other states, make sure you have Section 530 status or other leverage that avoids federal penalties for wrong classifications.

We don’t have any precedent yet on how workers can avoid the AB 5 W-2 classification, but you have to think that forming an S corporation or a C corporation would help meet the ABC test. Many workers who pay their own expenses have a vested interest in avoiding the W-2 classification because employee business expenses are not deductible for years 2018-2025.

Our CPA Takeaways

If your business has workers in California, you need to determine how AB 5 impacts your classification of them as employees or independent contractors.

The new, stricter ABC test could mean the worker would normally be an independent contractor under federal common-law standards, but an employee for purposes of California law.

If your workers are subject to the ABC test, consider the following:

  • Ensure your business has insufficient control over the worker to meet the A prong.
  • Define your core business activity and how it does not relate to the services provided by the worker to meet the B prong.
  • Use true independent contractors (who have required business licenses, have clients in addition to your business, and advertise themselves as available for business, for example) and get documentation prior to selecting them to meet the C prong.

If your business is outside of California and you have California contractors, you face the rules above. Further, your state may be looking to enact an AB 5 type of law, so be alert (and perhaps get involved).